U.S. Regulation of the International Securities and ... · offerings. Securities purchased in U.S. private offerings are viewed as "restricted" under SEC rules and thus may not be

U.S. Regulation of the International Securities and Derivatives Markets, §7.01, INTRODUCTION

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U.S. Regulation of the International Securities and Derivatives Markets, §

7.01, INTRODUCTION

U.S. Regulation of the International Securities and Derivatives Markets1 Edward F. Greene, Alan L. Beller, Edward J. Rosen, Leslie N. Silverman, Daniel A. Braverman, Sebastian R.Sperber, Nicolas Grabar & Adam E. Fleisher, U.S. Regulation of the International Securities and DerivativesMarkets § 7.01 (11th and 12th Editions 2014-2017)11th and 12th Editions

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Cross-border securities offerings are regularly conducted without registration under the Securities Act, in relianceon exemptions for private offerings and for transactions conducted outside the United States—and often inreliance on both exemptions at once. This chapter discusses the exemption for private offerings, while Chapter 8discusses the exemption for transactions conducted outside the United States.

Offerings by issuers are exempt from registration under § 4(a)(2) of the Securities Act if they are "[t]ransactionsby an issuer not involving any public offering." These are usually referred to as "private placements" or "privateofferings." Over more than half a century, a substantial body of case law and SEC regulatory practice hasdeveloped concerning private placements by U.S. issuers and the resale of privately placed securities. [1]

Standardized procedures and documentation have also evolved to allow private placements to proceed withassurance that the exemption from registration under § 4(a)(2) is available.

Private offerings have come to represent a significant portion of total U.S. financing activity, particularly since theSEC adopted Rule 144A under the Securities Act in 1990. [2] Many U.S. issuers rely on the private offeringexemption to sell specialized securities that are tailored for the investing institutions. In such cases, the ability toresell the securities in a liquid market is not a primary consideration. Where liquidity is important to investors,however, the price the issuer receives in a private offering has historically been lower than in a publictransaction, and investors often require the issuer to provide "registration rights"—a prompt avenue to resell inthe public market via either a subsequent resale registration statement or a subsequent registered A/B exchangeoffer—as a condition to purchase. While Rule 144 now provides most purchasers of securities in a privateplacement the ability to resell publicly one year (or, in the case of reporting companies, six months) afterpurchase, registration rights are still for a number of reasons not uncommon in Rule 144A offerings. [3]

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Foreign issuers, on the other hand, often seek to place privately in the U.S. institutional market the same kinds ofsecurities that they sell in their domestic markets or in international markets. They also seek the same pricing asthey receive in those markets. The market for such private offerings by foreign issuers is well established andincludes a broad range of U.S. institutional investors, reflecting the growing liquidity in overseas public marketsand the growth of cross-border investing generally.

The principal reasons for the complexities of the private offering process, and for the lack of liquidity in the U.S.private offering market, are legal and regulatory. There have been two main areas of legal and regulatory focusto facilitate private offerings: providing issuers and participating financial institutions with certainty that an offeringis exempt from registration under § 4(a)(2) of the Securities Act; and providing investors with flexibility to resellsecurities purchased in a private offering to increase liquidity. While these developments affect private offeringsgenerally, they are particularly relevant to foreign issuers considering the U.S. private offering market.

With respect to providing certainty regarding the § 4(a)(2) exemption, since 1974, the SEC has provided safeharbor rules, now included in Regulation D under the Securities Act, for private offerings by issuers. While mostU.S. private offerings to institutions by foreign issuers are made in reliance on § 4(a)(2) itself rather thanRegulation D, [4] the safe harbor procedures provide important guidance on how to conduct U.S. private© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.


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offerings.

Securities purchased in U.S. private offerings are viewed as "restricted" under SEC rules and thus may not beimmediately resold publicly in the U.S. secondary market. [5] Since 1972, the SEC has provided a safe harborunder Rule 144 that permits unlimited resales of restricted securities in the public market by

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non-affiliates of the issuer after an initial holding period, which is currently six months for securities of an SEC-reporting issuer (provided the issuer has filed its required periodic reports under § 13 or 15(d) of the ExchangeAct), [6] and one year for securities of other issuers. [7]

U.S. investors can immediately resell restricted securities into markets outside the United States and to qualifiedprivate placement investors in the United States, provided they satisfy certain conditions. Resales outside theUnited States of restricted securities of a foreign issuer were first approved by the SEC in a series of no-actionletters beginning in the late 1980s, [8] and since 1990, they have been permitted by Regulation s under theSecurities Act. [9] This is important for equity securities of foreign issuers because the home market generally hasmore depth, and the securities can in effect be sold in the "regular way" in that market.

Before the adoption of Rule 144A, resales of restricted securities to qualified U.S. investors had long beenconducted under a legal analysis developed by the U.S. private bar and referred to as the "Section 4(1 ½)exemption." [10] In 1990, the SEC adopted Rule 144A, a safe harbor permitting resales to large institutionalinvestors. The growing reliance on Rule 144A for U.S. institutional resales has led to the development ofstandardized practices for "Rule 144A offerings." Rule 144A offering practices differ from those in traditional §4(a)(2) private

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placements, which prevailed before the advent of Rule 144A and are still sometimes conducted today. Rule144A offerings are typically conducted on an underwritten basis, with terms and conditions substantially identicalto those applicable to public offerings. In the case of debt securities, the investment banks that act as initialpurchasers and resell in reliance on Rule 144A negotiate the terms of the securities to be offered, while atraditional private placement may involve direct and often protracted negotiations between the issuer and theultimate investors.

A consensus has also developed within the private securities bar as to appropriate documentation with respectto Rule 144A offerings. [11] In connection with traditional private placements, the private bar has generallyrequired letters from each purchaser (often referred to as nondistribution letters or investment letters) to negatethe presence of a distribution subject to Securities Act registration, but these are not required from purchasersunder Rule 144A. [12] Other similar requirements developed by the private bar, such as large minimumdenominations, the use of legended physical securities and stop-transfer procedures, are also not necessary inconnection with an offering made exclusively to "qualified institutional buyers," or "QIBs," under Rule 144A. [13]

Regulation M under the Exchange Act specifically exempts Rule 144A offerings from limitations on trading duringa distribution, [14] and securities sold in Rule 144A offerings are eligible for clearing at The Depository TrustCompany ( "DTC"), the principal U.S. clearing organization, which further facilitates trading under Rule 144A.Aftermarket trading in Rule 144A debt securities is also required to be reported to the Financial IndustryRegulatory Authority, Inc. ( "FINRA"), through the Trade Reporting and Compliance Engine ( "TRACE"). [15]

Some concerns about the U.S. private placement market remain for non-U.S. issuers. Some foreign issuers arereluctant to submit to customary market practices incidental to a U.S. private offering, which even if limited toinstitutional investors and carried out under Rule 144A can involve procedures that

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foreign issuers find intrusive, including extensive "due diligence" inquiries and the need for accountants' andlawyers' negative assurances as to the quality of disclosure provided to initial investors. The requirement underRule 144A that a nonreporting issuer covenant to provide certain information to purchasers and prospective© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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purchasers in secondary market transactions has also sometimes raised questions for foreign issuers.Notwithstanding these concerns, offerings under Rule 144A by foreign issuers have been a popular approach tothe U.S. markets since the Rule's adoption.

Footnotes

1 See § 7.02 for a discussion of certain of the principal precedents and SEC rules regarding privateplacements.

2 According to a published summary of capital markets activity in the United States, in 2015, there were 535private placements of debt and equity in the U.S. market that raised a total of U.S.$137.0 billion. Bycomparison in 2015, there were 4,000 SEC-registered public offerings of debt and equity in the U.S. marketthat raised a total of approximately U.S.$2.1 trillion. Securities Industry and Financial Markets Association( "SIFMA"), 2016 Fact Book.

3 See § 7.05 for a discussion of registration rights.4 See § 7.02[2].5 Rule 144(a)(3) under the Securities Act defines "restricted securities" as, inter alia,

(i) securities acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in atransaction or chain of transactions not involving any public offering, (ii) securities acquiredfrom the issuer that are subject to the resale limitations of Rule 502(d) under Regulation D orRule 701(c), (iii) securities acquired in a transaction or chain of transactions meeting therequirements of Rule 144A, (iv) securities acquired from the issuer in a transaction subject tothe conditions of Regulation CE, and (v) equity securities of domestic issuers acquired in atransaction or chain of transactions subject to the conditions of Rule 901 or Rule 903 underRegulation s.

Securities (other than equity securities of domestic issuers) offered in offshore offerings pursuant toRegulation s are not regarded as "restricted securities." For a discussion of resale restrictions applicable tosecurities originally sold under Regulation s under the Securities Act, see § 8.02.

6 Rule 144(c) under the Securities Act. Timely filing of current reports on Form 8-K (for domestic issuers) orreports on Form 6-K (for foreign private issuers) is not a requirement for this purpose.

7 Rule 144(d) under the Securities Act. The current holding period has been in effect since 2008. See SECRelease No. 33-8869 (Dec. 6, 2007). The holding period was originally three years and in 1997 was reducedto one year (subject to conditions relating to current public information, volume of sales, manner of sale andfiling of Form 144) or two years (after which these conditions ceased to apply).

8 See, e.g., French Privatization Program (avail. Apr. 17, 1987); College Ret. Equities Fund (avail. Feb. 18,1987).

9 Rule 904 of Regulation s under the Securities Act. Resales under Regulation s are discussed in § 7.04[5].10 See § 7.04[3]. See generally Law of Private Placements (Non-Public Offerings) Not Entitled to Benefits of

Safe Harbors—A Report, 66 BUS. LAW, 85 (2010) (a Report by the Committee on Federal Regulation ofSecurities, ABA Section of Business Law); The Section 4(1 ½) Phenomenon: Private Resales of

"Restricted" Securities, 34 BUS. LAW, 1961 (1979) (a Report to the Committee on Federal Regulation ofSecurities from the Study Group on Section 4(1 ½) of the Subcommittee on 1933 Act) ( "The Section 4(1 ½)

Phenomenon"); SEC Release No. 33-6806 (Oct. 25, 1988).Resales of restricted securities may now also be effected under § 4(a)(7) of the Securities Act, added to the

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Securities Act in December 2015. Although subject to certain limitations not thought by the private bar to beapplicable to § 4(1 ½) resales, the non-exclusive safe harbor provided by § 4(a)(7) should be particularlyuseful in resales of restricted securities to accredited investors that are natural persons rather thaninstitutional investors.

11 See § 7.04.12 See § 7.02[3].13 See text accompanying infra Note 80.14 Rule 102(b)(7) under Regulation M. Prior to the adoption of Regulation M in 1996, Rule 10b-6 under the

Exchange Act imposed limitations on trading by distribution participants in private placements that wereconsidered distributions for purposes of Rule 10b-6. See SEC Release No. 34-38067 (Dec. 20, 1996); §7.10.

15 FINRA Rule 6750 requires that information about aftermarket Rule 144A transactions be publiclydisseminated immediately upon FINRA's receipt of the transaction report. See SEC Release No. 34-70345(Sept. 6, 2013).


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U.S. Regulation of the International Securities and Derivatives Markets, §7.02, INSTITUTIONAL…

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7.02, INSTITUTIONAL PRIVATE PLACEMENTS


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[1] Securities Act § 4(a)(2)

The legal basis for private placements and for subsequent resales among institutions and dealers derives fromthe exemptions from registration found in §§ 4(a)(1), 4(a)(2) and 4(a)(3) of the Securities Act. Section 4(a)(1)exempts from the registration requirements of the Securities Act "[t]ransactions by any person other than anissuer, underwriter or dealer"; § 4(a)(2) exempts "[t]ransactions by an issuer not involving any public offering";and § 4(a)(3) exempts transactions by a dealer not acting as an underwriter. [16] The Securities Act defines anunderwriter to include "any person who has purchased from an issuer with a view to, or offers or sells for anissuer in connection with, the distribution of any security, or participates or has a direct or indirect participation inany such undertaking, or participates or has a participation in the direct or indirect underwriting of any suchundertaking." [17] One key to these exemptions lies in the twin concepts of a "public offering" and a "distribution"of securities: if there is no public offering, there is no distribution within the meaning of the Securities Act; and, ifthere is no distribution, there can be no underwriter, so that if there is no public offering, the issuer can find anexemption for its offers and sales under § 4(a)(2), the dealer under § 4(a)(3) and all others under § 4(a)(1) of theSecurities Act.

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Whether a public offering has occurred may depend not only on the nature of the issuer's initial offer and sale ofsecurities to a purchaser but also on the nature of subsequent reoffers and resales. If a purchaser from an issuer(or under prevailing SEC positions, any purchaser in a chain of sales from the issuer) resells in such a mannerthat the securities are distributed to the public, the selling party may be an underwriter and thus not be entitled toan exemption under § 4(a)(1) (or § 4(a)(3) in the case of dealers) and the issuer may not be entitled to anexemption under § 4(a)(2). [18]

What constitutes a "public offering" and, therefore, a distribution for purposes of the securities laws has been thesubject of intense discussion. Starting immediately after the adoption of the Securities Act, requests for guidanceconcerning the § 4(a)(2) exemption were sufficiently numerous to prompt the General Counsel of the SEC toattempt a clarification of the "public offering" concept in 1935. The General Counsel's opinion established that 25offerees were generally permissible in a private offering, and also enumerated four factors that the SEC wouldtake into account in determining the existence or absence of a public offering. Those factors were (i) the numberof offerees and their relationship to each other and to the issuer, (ii) the number of units offered, (iii) the size ofthe offering and (iv) the manner of the offering. [19]

After a number of conflicting lower court decisions, in 1953 the U.S. Supreme Court in SEC v. Ralston Purina

Co. [20] attempted to clarify the scope of the private offering exemption by declaring that a public offering was onein which the investors required the protections applicable to public offerings; private offerings were those inwhich such protections were not needed: "[T]he applicability of [§ 4(a)(2)] should turn on whether the particularclass of persons affected needs the protection of the [Securities] Act. An offering to those who are shown to beable to fend for themselves is a transaction ‘not involving any public offering.’" [21]

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The Court in Ralston Purina determined that "[§ 5] would seem to apply to a ‘public offering’ whether to few ormany." [22] Consequently, the Court did not fix a maximum number of offerees that would ensure the absence ofa public offering. [23] Although Ralston Purina continues to be the seminal judicial pronouncement concerningprivate offerings, its effect was as much to increase the number of potential factual considerations appropriate toa § 4(a)(2) analysis as to focus the inquiry on the nature of prospective investors. [24]

The concept of investors "able to fend for themselves" was not as obvious as it seemed at first blush. The courtsruled that sophistication alone was not necessarily sufficient to ensure availability of the exemption; [25] aprospective investor's relationship with the issuer, based on factors such as employment, family or economicbargaining power, could be sufficient. [26] In addition, the burden to prove the availability of the exemption isplaced on the person seeking to take advantage of it [27] and failure to satisfy the burden results in strict liabilityfor the "seller." [28]

Notwithstanding the uncertainties regarding the private offering exemption under § 4(a)(2), the securities bardeveloped procedures and documentation for offerings before and after Ralston Purina that sought to takeadvantage of the

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exemption. The focus of these procedures was on the factors highlighted, albeit not consistently or uniformly, bythe SEC and the courts, including the manner of offering, the number, wherewithal and sophistication of offereesand the relationship between the offerees and the issuer.

Even though the private offering market continued to operate, the SEC was pressured by market participantsand the private bar, in light of the unease produced by the case law under § 4(a)(2) and the draconian liabilitythat could result if the exemption were not available—rescission by all purchasers—to provide certainty as to theavailability of the exemption. In response, the SEC in 1974 adopted a nonexclusive "safe harbor" rule for privateofferings. [29] Eight years later, the SEC adopted Regulation D under the Securities Act, a more comprehensive,but still nonexclusive, safe harbor rule. [30]

[2] Regulation D

Rule 506 under Regulation D provides a safe harbor from registration for offers and sales by issuers. Prior to theSEC's implementation of § 201(a) of the Jumpstart Our Business Startups Act (the "JOBS Act") in 2013, one ofthe conditions for reliance on the safe harbor was that neither the issuer nor any person acting on its behalfcould offer or sell securities under Regulation D by any form of general solicitation or general advertising.Section 201(a) of the JOBS Act directed the SEC to amend Rule 506 to permit general solicitation or generaladvertising in offerings under the Rule, subject to certain additional conditions. As a result, the SEC adoptedchanges to Rule 506 that left the existing safe harbor unchanged, but redesignated it as Rule 506(b), and addeda new safe harbor in Rule 506(c), under which a private offering may make use of general solicitation andgeneral advertising. [31] These safe harbors cannot be used for transactions other than offers and sales by anissuer. [32] Securities acquired in an offering

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made under Regulation D are "restricted" for purposes of the Securities Act registration requirements. [33]

[a] General Requirements

To qualify for the safe harbor under Rule 506(b), all of the following conditions must be met:

• Neither the issuer nor any person acting on its behalf may offer or sell the securities by any form ofgeneral solicitation or general advertising. [34]

• Sales may only be made to "accredited investors" plus up to 35 persons who are not accreditedinvestors. There is no limitation on the number of "accredited investors" to which sales may be made. [35]


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• If any purchaser is not an accredited investor, then (i) the issuer must "reasonably believe" that eachsuch purchaser "has such knowledge and experience in financial and business matters that he iscapable of evaluating the merits and risks of the prospective investment" [36] and (ii) each such purchasermust receive prior to sale certain information specified by the regulation,

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which is broadly similar to that required to be provided in an SEC-registered offering. [37]

• The issuer must exercise "reasonable care" to ensure that the purchasers of the securities are notunderwriters within the meaning of § 2(a)(11) of the Securities Act (also referred to as "statutoryunderwriters")—that is, that they are not taking with a view to, or offering or selling for the issuer inconnection with, a distribution of the securities. [38]

• The issuer must file a notice of the offering on Form D [39] with the SEC no later than 15 days after thefirst sale of securities in the offering. [40]

The safe harbor under Rule 506(c) differs from the safe harbor under Rule 506(b) in five respects:

• The requirement that there be no general solicitation or general advertising does not apply. [41]

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• Sales may only be made to accredited investors. [42]

• The issuer must check a box on Form D to indicate whether it is relying on either Rule 506(b) or Rule506(c). [43] Some comments on the proposed rule suggested that an issuer might check both boxes—forexample, if general solicitation is contemplated but might not be used, or to protect against losing theexemption as a result of inadvertent solicitation. [44] The adopting release specifies that the issuer mustcheck one box or the other. [45] It would appear, however, that an issuer can amend a Form D for anoffering to select 506(b) after having selected 506(c) in a prior Form D filing for that offering or viceversa, assuming all other conditions are met.

• The requirement that certain information concerning the issuer be furnished to any investor other thanaccredited investors [46] does not apply, because only accredited investors may participate. [47]

• The issuer must take "reasonable steps to verify" that the purchasers are accredited investors. [48] This isan independent procedural requirement, and it must be met even if in fact all offerees happen to beaccredited investors.

[b] Required Reasonable Steps to Verify Accredited Investors in Rule 506(c)

Offerings

The "reasonable steps to verify" that an issuer must take in a Rule 506(c) offering was the subject of extensivecomment and is discussed at length in the adopting release. The release explains that it is a "principles-based"requirement, resting on "an objective determination by the issuer (or those acting on its behalf), in the context ofthe particular facts and circumstances of each purchaser and transaction." [49] Issuers should consider a numberof factors, and the

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release discusses three examples: the nature of the purchaser, the information the issuer has about thepurchaser, and the nature and terms of the offering. [50]

The final rule includes a safe harbor specifying acceptable, but nonexclusive, methods to verify the accreditedinvestor status of natural persons. [51] The addition of the safe harbor was widely sought in the comment processfollowing the proposed rule and is consistent with the SEC's decades-long practice of providing safe harborsfrom § 5 violations in light of the draconian consequences (in particular, a strict liability rescission right for© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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purchasers) for those violations.

Specifically, Rule 506(c) provides a nonexclusive list of methods to verify accredited investor status for naturalpersons that will be deemed to satisfy the verification requirement. These are (a) review of specifieddocumentation showing that a person meets the income test in the definition of accredited investor, [52] (b) reviewof specified documentation showing that a person meets the net worth test, [53] (c) reliance on writtenconfirmation from a third party that it has verified the person's accredited investor status [54] and (d) reliance oncertification from an existing investor who previously invested in a Rule 506(b) offering by the issuer. [55] Theissuer may not rely on the Rule 506(c) safe harbor if it or its agent has knowledge that the purchaser is not anaccredited investor. [56]

In addition to the new Rule 506(c), the SEC simultaneously adopted Rule 506(d) (pursuant to § 926 of the Dodd-Frank Act), which removes the protection of the Rule 506 safe harbor from offerings in which a "bad actor"participates. [57]

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Rule 506(d) applies if certain categories of persons are subject to certain disqualifying events.

The categories of persons are:

• the issuer, any predecessor, any affiliated issuer and any promoter;

• any director, executive officer, other officer participating in the offering, general partner or managingmember of the issuer;

• any beneficial owner of 20% or more of the issuer's outstanding voting equity securities;

• with respect to an issuer that is a pooled investment fund, any investment manager of the issuer;

• any person paid (directly or indirectly) to solicit purchasers in connection with sales in the offering ( e.g.,a placement agent); and

• with respect to any such investment manager or solicitor, (i) any general partner or managing memberand (ii) any director, executive officer or other officer participating in the offering of the investmentmanager, the solicitor or a general partner or managing member of the investment manager or solicitor.[58]

Disqualifying events include:

• criminal convictions in connection with purchases or sales of a security, making false filings with the SECor that arise from conducting business as an underwriter, broker-dealer, investment adviser or paidsolicitor;

• injunctions and court orders related to engaging in or continuing conduct or practices relating to suchactivities;

• final orders of certain federal and state regulators that either bar a person from engaging in securities,insurance, banking or similar activities (or from association with an entity regulated by the regulatorissuing the order), or that

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are based on a violation of any law or regulation prohibiting fraudulent, manipulative or deceptiveconduct;

• SEC cease-and-desist orders arising from a violation of § 5 of the Securities Act or scienter-basedantifraud provisions of the federal securities laws;

• certain other SEC orders (including suspension, revocation of registration or limitations on activities as abroker-dealer or investment adviser);


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• suspension, expulsion or being barred from association with a national securities exchange orassociation for improper conduct;

• filing or being named as an underwriter in a registration statement as to which a stop or suspensionorder was issued, or being the subject of an investigation to determine whether such an order should beissued; or

• U.S. Postal Service false representation orders and certain temporary restraining orders or injunctions.[59]

The time periods for disqualification generally address conduct arising from between five and ten years prior tothe date of the Rule 506 sale, although in certain cases an event will only be disqualifying if the injunction, order,investigation or similar event is in effect and continuing at the time of the Rule 506 sale.

Rule 506(d) limits disqualification to triggering events that occur after effectiveness of the Rule (September 23,2013), although the issuer will still be required to disclose past events that would be disqualifying if they hadoccurred after the effective date to purchasers in advance of sales under Rule 506 (unless the issuer canestablish that it did not know and reasonably could not have known of the existence of those past disqualifyingevents). Although this will still require issuers to determine whether any pre-adoption disqualifying events existfor purposes of disclosure, the change has helped to address at least some of the concerns raised bycommenters as to market participants who may have voluntarily entered into consent decrees or who wouldotherwise be disqualified based on prior conduct, but who were not in a position to know of the consequencesunder revised Rule 506.

Rule 506(d) also includes a waiver provision, under which a waiver of disqualification may be granted by theSEC upon a showing of good cause. [60]

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Rule 506(d) sets out a "reasonable care" exception, under which an issuer will not lose the benefit of the Rule506 safe harbor, despite the existence of a disqualifying event, if it can show that it did not know and, in theexercise of reasonable care, could not have known of the disqualification. The adopting release indicates theissuer will be expected to conduct a factual inquiry to rely on this exception and makes clear that the steps anissuer must take to be deemed to have exercised "reasonable care" will vary according to the particular factsand circumstances. [61] The release notes issuers will likely have in-depth knowledge of their own directors andofficers, and that additional inquiry "by means of questionnaires or certifications, perhaps accompanied bycontractual representations, covenants and undertakings, may be sufficient in some circumstances, particularly ifthere is no information or other indicators suggesting bad actor involvement." [62] The release also notes theSEC's expectation that market participants, such as placement agents and broker-dealers, will developprocedures to assist issuers in gathering the necessary information. Finally, for continuous, delayed or long-livedofferings, the release notes that the requirement to exercise reasonable care will include updating the factualinquiry on a "reasonable" basis, but that, in appropriate cases, periodic updating should suffice. [63]

Regulation D is a safe harbor: compliance with its requirements assures the availability of the private placementexemption. Because it is a nonexclusive safe harbor, however, failure to comply with its requirements does notpreclude reliance on § 4(a)(2) to conduct a good private offering. In fact, issuers and their legal advisersgenerally follow the guidelines of Regulation D as to the manner of conducting a private offering while notattempting formal compliance with the regulation itself. [64] In particular, foreign issuers, like many U.S. issuers,are

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reluctant to publicly disclose the information required by Form D, including the compensation paid to dealers. [65]

Many of the requirements built into Regulation D mirrored prior practice, and their adoption by the SEC providedsuch practice with new support, even if not all of the technical requirements of the regulation are followed. Other


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aspects of Regulation D were new developments. [66] Similarly, many of the procedures and practices thatdeveloped to ensure compliance with Regulation D were derived from offering practices that predated theregulation. However, the promulgation of the regulation, due to the specificity of its standards as compared to thevague case law under § 4(a)(2), has created greater consistency in the practices followed in private offerings ofsecurities, whether reliance is placed on Regulation D or on § 4(a)(2) itself.

The guidance provided by Regulation D concerning the types of activities that may constitute general solicitationor general advertising has become standard, and still relevant for issuers that seek to offer or sell securitiespursuant to Rule 506(b) or the statutory exemption in § 4(a)(2) of the Securities Act. [67] Although Rule 502(c)nonexclusively identifies certain activities that constitute a general solicitation, [68] many issuers have sought no-action advice from the SEC staff concerning particular situations. The general rule that has emerged from staffpositions is that no general solicitation will be found to have occurred if there is a pre-existing relationshipbetween the offeror (or its agent) and offeree,

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sufficient to permit the offeror to evaluate the financial sophistication of the offeree. [69]

Rule 502(d) of Regulation D specifies that the issuer must "exercise reasonable care to assure that thepurchasers of the securities are not underwriters"—in other words, that purchasers are not taking securities witha view to distribution. The Rule identifies certain steps that an issuer should consider implementing: (i)reasonable inquiry as to whether the purchaser is acquiring the securities for its own account or the account ofanother person, (ii) notice to purchasers that the securities in question have not been registered under theSecurities Act and cannot be resold unless registered or pursuant to an exemption from registration and (iii) theuse of an appropriate legend on the securities. The Rule states, however, that these steps are not the exclusivemeans of complying with the "reasonable care" test.

The private securities bar has developed a fairly consistent series of procedural steps intended to meet therequirements of Regulation D and also the less certain statutory standard of § 4(a)(2) itself. First, letters,commonly called "investment letters" or "nondistribution letters," are generally required of each buyer. In such aletter, the buyer generally (i) is notified and acknowledges that the securities in question were not registeredunder the Securities Act, (ii) certifies that it is a sophisticated investor and has received all information it hasrequested about the investment [70] and (iii) acknowledges that it is not purchasing the securities in question witha view to distribution (within the meaning of the Securities Act). Such letters often also include an agreement bythe buyer that in the absence of registration or, in certain cases, a clearly available exemption, [71]

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resales of the securities will only be permitted if accompanied by a legal opinion that the resale in question isexempt or if the resale complies with specified restrictions designed to provide sufficient assurances that anexemption from registration is available. Second, the securities are often either denominated, or offered andsold, in large amounts (in the hundreds of thousands or even millions of dollars) that are usual for institutionalprivate transactions but not characteristic of public offerings to retail investors. Third, the number of offerees,generally other than institutional accredited investors, is often limited. Fourth, if the securities are in physicalform, the certificates contain restrictive legends and are often subject to stop-transfer instructions to preventunapproved resales. Such instructions are a mechanism to apply to subsequent purchasers the transferrestrictions imposed on the original purchasers through investment or nondistribution letters. If the securities arenot in physical form, either because they are represented by interests in a global security or because they arepart of a paperless, book-entry system, other mechanisms may be used for the same purpose. [72]

Despite an overall fairly standard pattern, the exact combination of procedures used in a particular offering maydepend on the circumstances. Not all of these procedures are employed in all § 4(a)(2) offerings. For example,in private offerings of commercial paper, with its short maturities and relative lack of trading, the procedures areusually somewhat curtailed. Most important, if the securities to be offered are Rule 144A-eligible and are offeredand sold only to "qualified institutional buyers," or QIBs, as defined in Rule 144A, typically the procedures© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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implemented are quite limited, investment letters are not required and no policing of resales is considerednecessary. [73] Even if the securities are not Rule 144A-eligible (because, when issued, they were fungible withsecurities listed on a U.S. exchange), procedures can also remain relatively limited if the securities are offeredand sold only to QIBs and there is a bona fide market for these securities outside the United States. [74] Theprocedures in these cases generally would include a notice that the securities may only be resold outside theUnited States, investor letters confirming each purchaser's status as a QIB and an agreement by each purchaserto resell shares only outside the United States under Regulation s and not to conduct any hedging activities thatwould be in

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violation of the Securities Act, as well as procedures designed to restrict deposit of securities acquired during theoffering into any American Deposit Receipt ( "ADR") facility for a period of 40 days after commencement of theoffering.

[3] Rule 144A Private Placements

Rule 144A under the Securities Act, adopted in 1990, provides a nonexclusive safe harbor from registration forresales to institutions reasonably believed by the seller [75] to be QIBs. The securities may not be "of the sameclass" as, or fungible with, securities listed on a national securities exchange or traded on a U.S. automatedinter-dealer quotation system. [76] The Rule imposes only two procedural requirements: (1) the seller must takereasonable steps to ensure that purchasers are aware that the seller may be relying on the Rule and (2) in thecase of issuers (other than foreign governmental issuers) that do not report or furnish information to the SECunder the Exchange Act, purchasers must have a right to obtain prior to sale certain information concerning theissuer of the securities.

Although Rule 144A is a safe harbor only for resales, it provides a way for an issuer to conduct a privateplacement to large institutional investors without the cumbersome measures to police resales that otherwiseapply under § 4(a)(2) of the Securities Act or Regulation D thereunder. [77] The Rule provides that an investor ora dealer that reoffers or resells securities in compliance with the Rule is not engaged in a distribution and is notan underwriter. Rule 144A is premised on the theory that QIBs can "fend for themselves" and therefore do notneed the protections of the registration requirements of the Securities Act; accordingly, sales made only to QIBsare not considered to be distributions. Moreover, because QIBs are considered to be familiar with resalerestrictions, sales to them are thought to pose little risk that they could lead to a subsequent distribution.Because resales to QIBs under the Rule are not themselves distributions, and pose little risk of leading tosubsequent distributions, they are not public

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offerings, and an investor or dealer taking restricted securities purchased from an issuer and reselling them toQIBs is not an underwriter. Thus, the § 4(a)(1) exemption is available for investors (other than dealers) selling incompliance with the Rule, and the § 4(a)(3) exemption is available for dealers. [78] Finally, since the resales arenot public offerings, they are consistent with the requirement that an issuer's reliance on § 4(a)(2) or RegulationD be supported by reasonable care to assure that the purchasers of the securities are not underwriters. [79]

Consequently, Rule 144A, although it technically applies only to resales and not to offers and sales by issuers,effectively permits a simplified form of private offering by an issuer. It codifies a form of resale of privately placedsecurities in a manner that permits the use of simplified procedures both upon an issuer's initial sale and uponsuch resales. The procedures described above in connection with § 4(a)(2) and Regulation D privateplacements, including investment letters, limitations on the number of potential offerees (at least outside the safeharbor of Regulation D) and the use of legends, stop-transfer and other procedures that affect pricing andliquidity, are generally not required—either for the initial issuance if the securities are to be resold only underRule 144A, or for any subsequent resales relying on the Rule. [80] A key effect of this simplification is theenhanced marketability on original issuance of securities that may be resold in reliance on Rule 144A.© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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One of the objectives of Rule 144A was to make primary offerings of foreign securities available to U.S.institutions in the U.S. market through intermediaries (rather than forcing such investors to go to overseasmarkets) by making the private offering market in the United States more attractive to foreign issuers. [81] Theabsence of significant procedural limitations on trading under Rule 144A has increased the willingness of foreignissuers to offer their securities in the United States, both in separate offerings and in conjunction with larger,global offerings. Indeed, a firm commitment offering targeted to QIBs in the United States under Rule 144A isconducted very much like an underwritten public offering except that purchasers are restricted to largeinstitutional investors. [82] Preliminary offering memoranda are often circulated, standard documentation is used,and road shows are conducted to give eligible investors the chance to hear from and question management.

[a] Qualified Institutional Buyer

p. 7-22p. 7-23

The criteria for eligibility as a QIB depend on the type of institution involved. [83]

(i) Any institution in one of the following categories is a QIB if it owns, or invests on a discretionary basis, atleast $100 million in securities:

a) a corporation (other than a U.S. or foreign bank or thrift), [84] a partnership, [84.1] a not-for-profitorganization qualified under U.S. federal tax law, [85] or a "Massachusetts or similar businesstrust"; [86]

b) an insurance company; [87]

c) a public or private employee benefit plan or a trust fund for the benefit of such plans; [88] orp. 7-23p. 7-24

d) an entity registered under applicable U.S. federal statutes as an investment adviser, aninvestment company, a small business investment company, a business development companyor a small business development company. [89]

(ii) A securities dealer registered under the Exchange Act is a QIB if it owns, or invests on a discretionarybasis, at least $10 million in securities. Even if it does not meet this threshold, it is a QIB when it acts in a"riskless principal transaction" for a QIB—where it buys a security and makes a simultaneous offsettingsale of such security to a QIB. [90]

(iii) A registered investment company is a QIB if it is part of a "family" of registered investment companiesthat in the aggregate owns, or invests on a discretionary basis, at least $100 million in securities. Thisalternative is available to an investment company that does not meet the investment threshold on itsown, as described in paragraph (i)(d) above. Under the Rule, a family of investment companies meansany two or more investment companies registered under the Investment Company Act (other than a unitinvestment trust investing solely in shares of other registered investment companies) that have the sameinvestment adviser, or depositor in the case of unit investment trusts. [90.1] Advisers or depositors that aremajority-owned subsidiaries of the same parent or of one another will be considered to be the "same"adviser or depositor. [91]

(iv) A U.S. or foreign bank, thrift or equivalent institution is a QIB if it owns, or invests on a discretionarybasis, at least $100 million in securities and it also has net worth of at least $25 million. [92] The SECimposed the net worth test on the grounds that U.S. banks and thrifts, because they are federallyinsured, "effectively are able to purchase securities using public funds." [93] It extended the net worth

p. 7-24p. 7-25

test to foreign banks and thrifts and equivalent institutions for competitive reasons. [94]


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(v) Any entity is a QIB if all of its equity owners are QIBs. [95]

The SEC has clarified that a purchase under the Rule by an insurance company on behalf of one or more of itsseparate accounts that are not registered, or required to be registered, under the Investment Company Act willbe deemed to be a purchase by the insurance company. [96] It is not sufficient, in the case of a sale to aninvestment adviser or other fiduciary acting with discretion on behalf of another institution, that the adviser orfiduciary be a QIB—both the adviser or other fiduciary and the underlying account must meet the Rule'srequirements.

The Rule generally requires that securities holdings be valued at cost, unless the institution reports its holdingson the basis of market value and no current information regarding the cost of the securities has been published(in which case the securities may be valued at market). The Rule also specifies that the securities holdings of anentity's consolidated subsidiaries may be included in the calculation only if they are managed by the entity andthat the securities may not be included at all if the entity is itself a majority-owned subsidiary included in theconsolidated financial statements of another entity, unless the entity is an Exchange Act-reporting company.

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Securities issued or guaranteed by the United States and its instrumentalities, [97] securities held on margin andsecurities loaned out to borrowers [97.1] are permitted to be included in calculating the amount of securitiesinvestments by an institution, whereas bank deposit notes and certificates of deposit, loan participations, [98]

repurchase agreements, securities subject to repurchase agreements, borrowed securities and short positions insecurities [98.1] as well as currency, interest rate and commodity swaps may not be so included. [98.2] A broker-dealer may not include allotment securities in its calculation. [98.3]

Rule 144A specifies that sellers can rely on certain means identified in the Rule to establish that a prospectivepurchaser satisfies the securities ownership requirement. [99] The most widely used method among U.S. broker-dealers to establish that a prospective purchaser is a QIB is to rely on a "QIB list" maintained by a commercialservice. [100]

[b] Nonfungible Securities

A security's eligibility for resale under Rule 144A is determined when the security is issued. A security is noteligible for resale under Rule 144A if when

p. 7-26p. 7-27

issued it is "of the same class" as securities listed on a U.S. national securities exchange or quoted in a U.S.automated inter-dealer quotation system. The fungibility test of Rule 144A is intended to prevent the creation of"side-by-side" public and private markets in the same security, which could divert resales of the securities awayfrom the public market with possible adverse implications for the public market's liquidity and volatility. [101]

Securities of a particular class that are issued prior to the listing of that class (such as securities held bysignificant shareholders of an issuer at the time of its IPO, often referred to as "founder shares") are eligible forresale under Rule 144A if they can be specifically identified.

Rule 144A is not available with respect to the securities of any open-end investment company, unit investmenttrust or face-amount certificate company that is or is required to be registered under § 8 of the InvestmentCompany Act. [102]

Convertible and exchangeable securities present specific issues under the nonfungibility requirement. In general,securities that are convertible into or exchangeable for securities that are listed on a U.S. national securitiesexchange or quoted on a U.S. automated interdealer quotation system are not considered to be fungible withsuch listed or quoted securities if such convertible or exchangeable securities had an effective conversionpremium of 10% or more when issued. [103] In addition, warrants to purchase such U.S. listed or quoted securitiesare not considered fungible with such securities if the warrants are exercisable for at least three years afterissuance and had an effective exercise premium of 10% or more when issued. [104] Listed or quoted ADRs are© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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considered fungible with the class of securities that underlies them. [105] Mandatorily exchangeablep. 7-27p. 7-28

securities, which involve the issuance by issuer A of a debt security mandatorily exchangeable at its maturity intoa security, generally common stock, of issuer B (or, at A's election, its cash equivalent), raise additional issuesunder Rule 144A, particularly relating to the nonfungibility requirement. [106] The SEC has retained authority todesignate other securities as not fungible with listed or quoted securities, [107] but to date has not exercised itsauthority. Because not many debt or preferred stock issues are listed on a U.S. securities exchange, thequestion of fungibility arises less often than for common stock.

Whether a new issue of equity securities will be considered to be part of the "same class" as outstandingsecurities listed or quoted for purposes of Rule 144A depends on whether they are of substantially similarcharacter and whether the holders have substantially similar rights and privileges. Although used for many yearsand for a variety of purposes in the U.S. federal securities laws, [108] this standard has not been elaborated inSEC no-action letters. A difference in designation alone will not be sufficient to create distinct classes. [109] Ingeneral, if equity securities differ as to preference or voting rights, they will not be considered to be of the sameclass. [110] On the other hand, if equity securities have identical terms with respect to dividend, liquidation andvoting rights, but differ as to terms such as redemption or convertibility, they nevertheless may be deemed toconstitute a single class. [111]

In the case of preferred stock and debt securities, the SEC stated in the release adopting Rule 144A that issues"commonly viewed as different series will generally be viewed as different, nonfungible classes of securities forpurposes of Rule 144A." [112] The SEC stated, however, that preferred stock issues

p. 7-28p. 7-29

will be considered to be of the same class "if their terms relating to dividend rate, cumulation, participation,liquidation preference, voting rights, convertibility, call, redemption and other similar material matters aresubstantially identical." [113] Debt securities will be considered fungible if there is substantial identity in termsrelating to coupon rate, maturity, subordination, security, convertibility, call, redemption and any other materialterms. [114]

[c] Information Delivery

If the issuer of the securities is a reporting company under the Exchange Act, or if it is exempt from reportingunder Rule 12g3-2(b) thereunder, [115] Rule 144A does not impose any requirement concerning available publicinformation as a condition for resale under the Rule. There is also no information requirement if the issuer is aforeign government or government agency eligible to register securities under Schedule B to the Securities Act.[116]

Otherwise, however, Rule 144A provides that, as a condition to an exempt resale, the holder and the prospectivepurchaser must "have the right to obtain from the issuer" certain reasonably current information concerning theissuer. Documentation for Rule 144A offerings typically addresses this requirement by including an undertakingby the issuer to provide any information required by Rule 144A(d)(4) in connection with a future resale, unless itis reporting or exempt at that time. The existence of a reporting obligation in the issuer's home jurisdiction doesnot suffice. In the case of guaranteed securities, the SEC has stated that the information furnishing requirementdoes not apply if the guarantor is a reporting company under the Exchange Act or exempt pursuant to Rule12g3-2(b) thereunder; alternatively, the information furnishing requirement may

p. 7-29p. 7-30

be satisfied in the case of guaranteed securities by looking to information furnished under Rule 144A(d)(4)(i) bythe guarantor. [117] The Rule permits the seller or any of its agents, in addition to the issuer and its agents, todeliver the information to the prospective purchaser.


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The information required by Rule 144A is a brief description of the issuer's business and the products andservices it offers, its most recent balance sheet, profit and loss and retained earnings statements, and similarfinancial statements for that portion of the two preceding fiscal years during which the issuer has been inoperation. [118] The financial statements should be audited "to the extent reasonably available," and theinformation must be "reasonably current" in relation to the date of resale pursuant to the Rule. The Rule specifiesthat information will be deemed to be "reasonably current," in the case of a foreign private issuer, if it meets thetiming requirements of the issuer's home country or principal trading markets. [119]

p. 7-30p. 7-31

It has been suggested that the requirement to supply information could create additional liability for issuers underthe U.S. securities laws, including in particular civil liability under § 10(b) of the Exchange Act and Rule 10b-5thereunder. [120] This potential liability could also exist for any broker-dealer or other seller that provides theinformation to a prospective purchaser under Rule 144A. Rule 10b-5 imposes liability for material misstatementsor omissions made in connection with the sale of a security. To sustain a claim under Rule 10b-5, a plaintiff mustprove both that the defendant acted with scienter ( i.e., intentionally or recklessly) and that the plaintiff relied onthe misstatement or omission in making its purchase. Issuers (and broker-dealers) providing informationpursuant to Rule 144A(d)(4) may also be subject to liability for such information under state securities laws andthe common law. [121] A particular issue with respect to liability is whether the information delivery requirement ofRule 144A(d)(4) includes a duty of the issuer to update the information with material developments affecting theissuer's financial condition and results of operations [122]—in effect, to maintain an "evergreen" disclosuredocument—to avoid liability to purchasers who request the information.

Although these risks may be remote, a nonreporting foreign issuer should consider whether to avoid the Rule144A information requirement by complying with the conditions for the Rule 12g3-2(b) exemption from reporting,especially if a high volume of Rule 144A resales can be expected. [123] There is then no

p. 7-31p. 7-32

requirement to supply information as a condition to Rule 144A resales and no duty to keep information current orupdated other than to continue complying with the conditions for the Rule 12g3-2(b) exemption. [124] Complyingwith the Rule 12g3-2(b) exemption would, however, also permit the establishment of a public ADR program forthe issuer's securities without the issuer's consent, and this could be a disadvantage for an issuer that otherwiseprefers to prevent the establishment of unsponsored ADR programs. [125]

[d] Notice

Rule 144A requires that a seller and any person acting on its behalf "take reasonable steps to ensure that thepurchaser is aware that the seller may rely on [Rule 144A]." [126] This requirement will not in most cases presentany difficulties. If the sale is by an investment bank in connection with a purchase from an issuer in a privateplacement, the offering document will indicate that the bank and other members of the syndicate may rely uponthe Rule. If no offering document is prepared, such as where a block trade is being conducted on an"undocumented" basis, [127] notice may be provided in confirmations of sale. [128]

[4] Publicity and Marketing Consistent with Restrictions on General Solicitation

and General Advertising

Although the SEC has eliminated the prohibitions on general solicitation and general advertising applicable toRule 506(c) offerings and Rule 144A offerings, the prohibition on general solicitation and general advertisingcontinues to apply to offerings made under Rule 506(b) and the statutory exemption under § 4(a)(2). [129] A pressannouncement in or directed into the United States regarding a private offering, which is made prior tocompletion of the offering, may constitute a general solicitation or general advertisement of the offer and could

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p. 7-33

jeopardize the availability of these private placement exemptions. [130] There are, however, two rules that provide"safe harbor" protection by specifying that communications meeting specified conditions are not deemed to beoffers.

Rule 135c under the Securities Act provides a safe harbor for certain public announcements of unregisteredofferings by the issuer. It is similar to Rule 135, a safe harbor for announcements of registered public offeringsmade prior to the filing of a registration statement, but unlike Rule 135 it is available only to the issuer and not toa selling securityholder. To rely on the Rule 135c safe harbor, the issuer must be either subject to the reportingrequirements of § 13 or § 15(d) of the Exchange Act or exempt from Exchange Act reporting requirementspursuant to Rule 12g3-2(b) thereunder. [131] Rule 135c(b) provides that an issuer may announce an offering inthe form of a news release, written communication to securityholders or employees, or other publishedstatements. The announcement may include (i) the name of the issuer, (ii) the title, amount and basic terms ofthe securities offered, (iii) the amount sold by any selling securityholders, (iv) the time of the offering and (v) abrief statement of the manner and purpose of the offering without naming the participating financial institutions.[132] The announcement must also include a legend to the effect that the securities have not been registeredunder the Securities Act and may not be offered or sold in the United States absent registration or an applicableexemption. Rule 135c specifies that it is not available if the announcement is made to condition the market forthe offered securities. A foreign private issuer subject to Exchange Act reporting requirements must furnish acopy of any Rule 135c announcement to the SEC on Form 6-K. An issuer subject to the domestic reportingforms would instead file the announcement on Form 8-K. [133]

Rule 135e under the Securities Act provides a safe harbor for certain press-related activities outside the UnitedStates. It was adopted in 1997 to encourage issuers to grant the U.S. press equal access to offshore pressactivities in connection with offshore offerings. [134] Under Rule 135e, a foreign private issuer, foreign governmentissuer, or selling securityholder may give U.S. journalists access to offshore press activities relating to anoffering of securities without being deemed to have made an offer for the sale of a security within the meaning

p. 7-33p. 7-34

of § 5 of the Securities Act, engaged in "general solicitation" within the meaning of Regulation D or engaged in"directed selling efforts" within the meaning of Regulation s —provided that it respects certain conditions. Theseconditions are (i) at least part of the offering is conducted outside the United States, (ii) access is provided toboth U.S. and foreign journalists and (iii) any written materials released to journalists bear a specified legend andmeet certain other conditions. Issuers conducting side-by-side offshore offerings and U.S. private offerings mayrely on Rule 135e in conducting offshore press activities, so long as there is "an intent to make a bona fide

offering offshore." [135]

The elimination of the prohibitions on general solicitation and offers to non-QIBs in Rule 506(c) and Rule 144Aofferings, respectively, permits issuers and their agents to communicate with prospective investors in Rule 144Aand Rule 506(c) offerings with no limit on the method of communication or the number or type of investorsreached. Issuers may use, among other methods, cold calls, blast e-mails, advertisements, articles and othercommunications published in newspapers, magazines, on the Internet or in television or radio broadcasts. Theliberalization also allows communications about these kinds of offerings at conferences, promotional seminars orother meetings. Regardless of the prospective investors reached by these communications, the ultimate salesmust be made to investors reasonably believed to be QIBs (in Rule 144A offerings) or accredited investors (inRule 506(c) offerings).

Issuers and their agents should be aware that any communications made to prospective investors are, of course,still subject to the antifraud provisions of the securities laws and, in particular, § 10(b) of the Exchange Act andRule 10b-5 thereunder. In addition to liability concerns related to the purchasers in the offering itself, use ofgeneral solicitation may also expand the scope of potential liability for information contained in thesecommunications to secondary market participants, either with respect to the security being sold or othersecurities of the issuer. Furthermore, many foreign jurisdictions have their own rules and restrictions regarding© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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publicity in connection with offerings [136] that will require careful analysis and consultation with local counsel. Asa result, issuers and their agents should carefully consider the content, form and distribution of generalsolicitation communications. To date, offering participants do not appear to be

p. 7-34p. 7-35

making any dramatic changes to offering practices to take advantage of the added flexibility.

Nevertheless, some changes in practice with respect to press releases and other publicity about or at the time ofan offering pursuant to Rule 144A or Rule 506(c) seem likely over time. These press releases and othercommunications no longer need to comply with the strict requirements of Rule 135c under the Securities Act orother similar safe harbors. For example, participating financial institutions may now wish to include their nameson press releases. In light of liability concerns, however, it would still be prudent to limit the content and ensure itis consistent with the offering circular. The timing of offering press releases is unlikely to change—they areunlikely to be published prior to launch both to avoid liability concerns associated with making statements prior tofinalizing the content of the offering circular and also to preserve flexibility for the offering participants aboutwhether and when to launch the offering. [137]

In light of these liability concerns, issuers and participating financial institutions may also want to limit discussionof Rule 144A and Rule 506(c) offerings at conferences or other public speaking engagements to completedtransactions [138] and, after an offering has launched, to information consistent with the offering circular. [139]

Finally, the ability to use general solicitation permits issuers and their agents to expand the pool of potentialinvestors and contact investors with which they had no pre-existing relationship. Over time, paid referralagencies and other similar services may develop to facilitate this process. [140]

The publication of a research report on an issuer by a financial institution participating in a distribution ofsecurities of that issuer may be viewed as general solicitation, which would be inconsistent with the exemptionsunder Rule

p. 7-35p. 7-36

506(b) or § 4(a)(2). Accordingly, a financial institution that is participating in a U.S. private placement willordinarily cease publishing research on the issuer in the United States unless the research qualifies for a safeharbor under Rule 138 or Rule 139 under the Securities Act. These safe harbors were originally developed topermit continuation of research coverage during a registered offering, but the SEC and the private barunderstood them to be available also to permit publication of research during a Rule 144A offering, and the ruleswere amended in 2005 to codify that view. [141] In light of the adoption of Rule 506(c) and the change to Rule144A, financial institutions are no longer restricted from publishing research reports on an issuer conducting aRule 506(c) or a Rule 144A offering. However, given the liability concerns under Rule 10b-5, financial institutionsparticipating in these offerings are not likely to take advantage of this flexibility to publish research other than inthe ordinary course or that refers to a pending offering.

Rule 138 permits the publication of a research report about a qualifying issuer if the report relates to securitiesother than the type of securities being offered. Rule 139 permits issuer-specific research to continue if it meetscertain conditions and the issuer is eligible. Eligible issuers include seasoned Exchange Act-reporting companiesand nonreporting foreign private issuers that meet certain quantitative criteria for public float and tradingmarkets. Rule 139 also permits the inclusion of an issuer in an industry report under specified circumstances.[142] The safe harbors typically are not available where the offering is a debut offering in the issuer's homemarket.

If a foreign private issuer is offering securities outside the United States, the participating financial institutionsmay propose to publish research reports in advance of the offering—often referred to as "pre-deal" research—based on customary practices in the home jurisdiction or other markets where the securities will be offered; thisis particularly common in debut offerings. [143] For pre-deal research distribution in the United States, theparticipating financial institutions


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may rely on Rule 144A, which includes no prohibition on general solicitation and general advertising. They mustalso, however, consider limitations on the distribution of research in the United States that arise from the GlobalResearch Settlement and FINRA rules limiting interaction between investment banking and research personnel.[144] Among other things, the settlement strictly limits communications between investment bankers and researchanalysts at the investment banking firms that are party to it, while the FINRA rules prohibit investment bankers atmember firms from directing [145] a research analyst to engage in sales or marketing efforts related to an offeringor to engage in any communication with an investor about an offering. Compliance with these restrictions, aswell as concern over 10b-5 liability, led investment banking firms to refrain from distributing pre-deal research inthe United States even to eligible investors in Rule 144A offerings and traditional private placements.

The practice of holding meetings between research analysts and prospective investors to discuss an issuer andits securities prior to the commencement of marketing—often referred to as "investor education"—also presentsissues

p. 7-37p. 7-38

under the Global Research Settlement and FINRA rules. It is common in some markets outside the UnitedStates for meetings of this kind to occur in connection with a debut offering after the first public filing or otherpublic disclosure. When the offering will include a Rule 144A component, research analysts at the banksinvolved may wish to conduct investor education with investors in the United States. Considering the potentialliability for communications with investors during these meetings, analysts have generally only met with a limitednumber of QIBs despite the greater flexibility to engage with investors afforded by amendments to Rule 144Aintroduced by the JOBS Act. Investment banking personnel and representatives of the issuer may not participatein the meetings, and they must be organized and scheduled in compliance with the prohibition under the FINRArules on investment banking personnel directing research analysts to engage in sales and marketing efforts or tocommunicate with investors concerning an offering. The information concerning the issuer that is used ininvestor education should be consistent as to factual matters with what will be included in the preliminary offeringcircular, though it often includes the analyst's (but not the issuer's) projections. Written presentations used in themeetings generally are not delivered in a manner that allows investors to retain them.

There is also a wide range of pre-launch investor contacts that do not include research personnel, and a rangeof terminology to describe them. One common form is sometimes called "pilot fishing," "pre-sounding" or "testingthe waters"—contacts between the issuer and potential investors arranged by the investment bankers with aview to, for example, gauging investor interest, deciding whether to proceed with an offering, identifying issuersconsidered comparable, or developing an approach to valuation and the price range for launch. In privateofferings by foreign private issuers, pilot fishing may occur in a variety of circumstances, such as a Rule 144Aoffering that is part of a home-country IPO, or a proposed debt offering in difficult market circumstances.Similarly, in some Rule 144A offerings, the launch of marketing is preceded by investor meetings at which theissuer and the investment bankers make a road show style presentation but do not typically market a specificoffering (sometimes referred to as a "nondeal road show"); whether the launch then occurs depends on investorreceptivity and market conditions.

In these pre-launch marketing activities, as with investor education, the issuer information is consistent with whatwill be included in the offering circular, investors do not retain written presentations, and the meetings are limitedto QIBs. Some bank policies impose limits on the number of investors that may be contacted in some forms ofpre-launch marketing, and the laws of the home country or other markets may require further limitations.Sometimes difficult negotiations arise concerning whether the issuer's indemnification, under the purchaseagreement for the offering, should cover materials used in pilot fishing,

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pre-launch investor meetings or even investor education. Marketing to prospective "cornerstone" or "anchor"


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investors can raise some of the same issues. [146]

[5] Use of the Internet for Private Placements

As is the case with public offerings, the Internet provides an additional forum for private placements of securities,whether in the United States in reliance on § 4(a)(2) of the Securities Act or Regulation D thereunder or pursuantto Rule 144A or outside the United States in reliance on Regulation s. Because of the widespread public accessto the Internet, conducting a private offering through the Internet in a manner that complies with the requirementsfor a valid private offering—in particular limiting, in the case of § 4(a)(2), the number and type of offerees and(with respect to Rule 506(b) offerings under Regulation D as well) the prohibition on the use of generalsolicitation or general advertising [147]—poses particular challenges.

[a] Material Available on Unrestricted Websites

Despite the existence of appropriate, restricted access procedures for offering-related information on a website,issuers in private placements made pursuant to § 4(a)(2) or Rule 506(b), in which general solicitation is notallowed, are advised to refrain from including on their unrestricted websites information that can reasonably beexpected to encourage directly or indirectly interest in the offering or that could be deemed to have beenreleased primarily for the purpose of directly or indirectly encouraging interest in the offering. This includes allinformation about any aspect of the offering (other than what is permitted by Rule 135c). [148] It can alsoencompass information about the operations, financial position or prospects of the company, statements withrespect to the level of dividend payout, any predictions, projections, forecasts or opinions regarding the

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value of the company, any "corporate image" or other advertising not in the ordinary course of the company'sbusiness or inconsistent with its past practice and any information released through arranged press coverageabout the company. Information that relates solely to the company's products or services and the publication ofwhich is consistent with the company's past practice generally may be kept on an unrestricted website. As a rule,issuers in private offerings pursuant to § 4(a)(2) or Rule 506(b) should not establish or expand unrestrictedwebsites until after completion of the offering. [149]

[b] Electronic Road Shows

One component of private offerings for which issuers have made frequent use of the Internet is the road show.As in the case of public offerings, [150] the SEC has approved the use of the Internet to conduct road shows forprivate offerings in the United States. [151] In order to comply with § 4(a)(2) of the Securities Act, no-actionguidance has sought to ensure that the electronic road show is transmitted on behalf of a seller solely to personsreasonably believed to be QIBs (or accredited investors in Regulation D or traditional private placements). [152]

Other protective measures arising from no-action relief or traditionally advocated by counsel include measuressimilar to those in the context of road shows for public offerings. These include presenting the entire uneditedlive road show, [153] except for corrections of misstatements and deletions of dead air, making the offering circularavailable on the website, accessible only through a password-protected "button" on the site; restrictions ondownloading, videotaping or other copying and distribution of the road show's content, and consistency betweenthe road show and the offering circular. The limited no-action relief granted in the context of private offerings sofar suggests that unlimited viewings of a road show may be permitted until the offering is concluded.

[c] Non-U.S. Offerings

Special concerns arise when an issuer conducts through the Internet a private placement in the United Statesconcurrently with an offshore offering to

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non-U.S. persons under Regulation s. In such cases, the SEC staff has suggested some measures that could betaken in order to comply with § 4(a)(2) and Rule 506(b) of Regulation D, as the case may be, but has expresslyindicated that other types of measures may be sufficient to prevent offshore Internet offerings from being used tosolicit investors in a private placement in the United States. [154] Consistent with the staff's suggestions, personsresponding to the non-U.S. Internet offering should be prohibited from participating in the concurrent privateplacement in the United States, even if they would otherwise be qualified to do so. In addition, access to theoffering materials posted on the Internet for the Regulation s offering should generally be limited to those viewerswho first provide residence information (and who do not provide other information that would otherwise indicatethat they are U.S. persons). [155] Finally, unless password protections are put in place, the posted offeringinformation should generally be limited to information about the non-U.S. offering, except for information aboutthe U.S. offering required by applicable non-U.S. law to be provided to investors participating in the non-U.S.offering.

[d] Electronic Document Distribution

Just as the SEC has expressly permitted the Internet to be used for the dissemination of mandatory disclosuredocuments in a U.S.-registered offering, [156] the Internet may also be used to distribute disclosure documents ina Regulation D private placement, a Rule 144A transaction or a traditional private placement, provided that therelevant requirements applicable to these types of offerings are satisfied. [157] The same considerations applyingto hyperlinks in the context of

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public offerings apply in private offerings as well. [158] In addition, many market participants now distributedisclosure documents in Rule 144A transactions or other private offerings by e-mail; prior to the changes, toRule 144A permitting general solicitation, such e-mails typically included a legend as to the possible relianceupon an exemption from the registration requirements under the Securities Act and the restrictions onredistribution of such disclosure documents. Although broad-reaching redistribution is no longer restricted byRule 144A, the inclusion of legends on such e-mails is unlikely to change given the 10b-5 liability concernsdiscussed above. [159]

[6] Integration Concerns and Mixed Private/Public Offerings

All sales that are part of "the same Regulation D offering" must meet all the requirements for the exemption. This"integration" doctrine was developed to prevent a public offering from being divided into multiple "private"offerings to avoid registration. Regulation D provides a safe harbor from this "integration" doctrine with respect tooffers and sales made more than six months before or after the transaction under consideration. [160]

The ability to use general solicitation in Rule 506(c) offerings raised integration questions in the context ofproximate private offerings. If a Rule 506(c) offering that uses general solicitation is integrated with a Rule 506(b)offering, the general solicitation will result in the loss of the Rule 506(b) exemption and any sales tononaccredited investors will be a violation of § 5. [161]

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If an issuer conducts a private offering of securities in close temporal proximity to a registered public offering, itcould be argued that the two offerings should be integrated and viewed as a single distribution of securities. [162]

If the private offerings are conducted under Rule 506(b) or § 4(a)(2), the resulting integrated offering would beillegal because the private offering exemption would be unavailable due to the general solicitation involved in thepublic offering. The offers and sales in the prior private offering (including private offerings under Rule 506(c) orRule 144A) might also constitute an illegal public offer in connection with the registered public offering (so-called"gun jumping") in violation of § 5 of the Securities Act. The SEC has, however, provided some relief in this areathrough Rules 152 and 155 under the Securities Act, as well as no-action positions and interpretive guidance.


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Rule 152 provides generally that a transaction that qualifies for the § 4(a)(2) exemption will continue to beexempt even if the issuer subsequently decides to make a public offering of the securities or files a registrationstatement. The SEC staff has clarified this Rule by taking the position that the filing of a registration statementfollowing an offering otherwise exempt under § 4(a)(2) for the same securities does not vitiate the exemption, solong as the private offering is completed prior to the filing of the registration statement. [163] In Black Box Inc., thestaff indicated that the execution of binding purchase agreements for a private offering that were not subject toconditions within the control of the purchasers could constitute "completion" for these purposes even though theclosing of the private offering had not occurred prior to the filing of the registration statement. [164] In Privatization

of the United States Enrichment Corp., the SEC staff indicated that abandonment of a private offering could alsoconstitute completion for purposes of Rule 152. [165]

In Squadron, Ellenoff, Pleasant & Lehrer, the SEC staff confirmed that it intended Black Box to represent a policyposition not to integrate a private placement to QIBs under Rule 144A (along with a private placement to up tothree large institutional accredited investors that were not QIBs) with a concurrently registered public offering ofthe same class of securities. [166] The staff noted in Squadron, however, that the mere filing of a registrationstatement will generally be considered as a general solicitation, even where the issuer does not circulate a "redherring" prospectus or make any press announcement concerning the proposed offering. [167]

In its 2007 proposal to revise Regulation D, the SEC provided further guidance regarding the integration ofconcurrent public and private offerings, reiterating and elaborating on its position set out in Black Box andSquadron. The SEC clarified that, while there are many situations in which the filing of a registration statementcould serve as general solicitation or general advertising for a concurrent private offering, the filing of aregistration statement does not per se eliminate a company's ability to conduct a concurrent private offering. Thedetermination as to whether the filing of the registration statement should be considered to be general solicitationor general advertising that would affect the

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availability of the § 4(a)(2) exemption for such a concurrent unregistered offering should be based on aconsideration of whether the investors in the private placement were solicited by the registration statement, orinstead through some other means that would otherwise not foreclose the availability of the § 4(a)(2) exemption,such as through a substantive, pre-existing relationship with the company or direct contact by the company or itsagents unrelated to the registration statement or the public offering effort. [168]

Rule 155 under the Securities Act provides a safe harbor for a registered offering following an abandoned privateoffering and for a private offering following an abandoned registered offering. Rule 155 facilitates a switch from aprivate offering to a registered public offering and vice versa in response to changing securities markets; it doesnot, however, modify or rescind the five-factor test for assessing integration in Regulation D, Rule 152 or theSEC guidance described above. [169]

Under Rule 155(b), an issuer that begins a private offering may subsequently commence a registered offering[170] without the risk that both offerings will be integrated if the following conditions are met:

• no securities were sold in the private offering;

• the issuer and any person acting on its behalf terminate all offering activity in the private offering beforethe issuer files the registration statement for the registered offering;

• any prospectus filed as part of the registration statement discloses information about the abandonedprivate offering, including the size and nature of the private offering, the date on which the issuerterminated all offering activity in the private offering, that any offers to buy or indications of interest in theprivate offering were rejected or otherwise not accepted and that the prospectus delivered in theregistered offering supersedes any selling material used in the private offering; and

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• the issuer does not file the registration statement until at least 30 calendar days after termination of alloffering activity in the private offering, except that the 30-day delay does not apply if the issuer and anyperson acting on its behalf offered securities in the private offering only to persons who were (or who theissuer reasonably believes were) accredited investors or who satisfy the knowledge and experiencestandard of Rule 506(b)(2)(ii) under the Securities Act.

Under Rule 155(c), an issuer that begins a registered offering may subsequently commence a private offeringwithout the risk that both offerings will be integrated if the following conditions are met:

• no securities were sold in the registered offering;

• the issuer withdraws the registration statement for the registered offering; [171]

• the issuer and any person acting on its behalf do not commence the private offering earlier than 30calendar days after the effective date of withdrawal of the registration statement;

• the issuer notifies each offeree in the private offering that the offering is not registered under theSecurities Act, the securities offered will be "restricted securities" as defined in Rule 144 under theSecurities Act and cannot be resold without registration unless an exemption is available, purchasers donot have the protection of § 11 of the Securities Act and a registration statement for the abandonedoffering was filed and withdrawn, specifying the effective date of the withdrawal; and

• any disclosure document used in the private offering discloses any changes in the issuer's business orfinancial condition that occurred after the issuer filed the registration statement that are material to theinvestment decision in the private offering.

Each of the specific conditions must be satisfied in order to take advantage of the Rule 155 safe harbor;however, it is not available for transactions that are

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part of a plan or scheme to avoid registration even if the issuer technically complies with the requirements of theRule. [172]

Footnotes

16 Section 4(a)(3) of the Securities Act is not available (i) for sales of securities by a dealer taking place prior tothe expiration of 40 days after the first date on which any of such securities were "bona fide offered to thepublic by the issuer or by or through an underwriter" or (ii) at any time with respect to an underwriter'sunsold allotment securities. In a private placement that is part of a larger, non-U.S. public offering ofsecurities, the 40-day § 4(a)(3) restriction on dealer sales is applicable commencing on the initial offeringdate of the non-U.S. offering, which is generally the date on which the offering price of the securities isdetermined.

17 § 2(a)(11) of the Securities Act.18 See, e.g., Gilligan, Will & Co. v. SEC, 267 F.2d 461, 466 (2d Cir.), cert. denied, 361 U.S. 896 (1959). In

proposing amendments to Rule 144 in 1997, the SEC stated that:

[i]ndividual investors who are not professionals in the securities business may be"underwriters" [and taking "with a view to … distribution"] within the meaning of that term asused in the [Securities] Act if they act as links in a chain of transactions through whichsecurities move from an issuer to the public.


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SEC Release No. 33-7391 (Feb. 20, 1997), 62 Fed. Reg. 9246, 9256 (Feb. 28, 1997).19 Op. Gen. Counsel, SEC Release No. 33-285 (Jan. 24, 1935).20 SEC v. Ralston Purina Co., 346 U.S. 119 (1953).21 SEC v. Ralston Purina Co., 346 U.S. 119, 125 (1953). Ralston Purina actually refers to § 4(1), because

what is now § 4(2) of the Securities Act was included in a second clause of § 4(1) until 1964.22 SEC v. Ralston Purina Co., 346 U.S. 119, 125 (1953). Footnote 11 to the quoted text cites Nash v. Lynde,

[1929] A.C. 158, 169 (H.L.) (U.K.): "[t]he ‘public’… is of course a general word. No particular numbers areprescribed. Anything from two to infinity may serve; perhaps even one, if he is intended to be the first of aseries of subscribers, but makes further proceedings needless by himself subscribing the whole." SEC v.

Ralston Purina Co., 346 U.S. 119, 125 n.11 (1953).23 SEC v. Ralston Purina Co., 346 U.S. 119, 125 (1953).24 See, e.g., SEC v. Continental Tobacco Company of South Carolina, Inc., 463 F.2d 137, 158 (5th Cir. 1972);

Henderson v. Hayden, Stone Inc., 461 F.2d 1069, 1071–72 (5th Cir. 1972); Hill York Corp. v. American

International Franchises, Inc., 448 F.2d 680, 687–89 (5th Cir. 1971); SEC v. Murphy, 626 F.2d 633, 645–47(9th Cir. 1980).

25 See, e.g., Doran v. Petroleum Management Corp., 545 F.2d 893, 902–03 (5th Cir. 1977), aff'd, 576 F.2d 91(5th Cir. 1978), and cases cited therein; Hill York Corp. v. American International Franchises, Inc., 448 F.2d680, 690–91 (5th Cir. 1971).

26 See, e.g., SEC v. Continental Tobacco Company of South Carolina, Inc., 463 F.2d 137, 159 (5th Cir. 1972);Western Federal Corp. v. Erickson, 739 F.2d 1439, 1443 (9th Cir. 1984).

27 SEC v. Ralston Purina Co., 346 U.S. 119, 126 (1953); see also Mark v. FSC Securities Corp., 870 F.2d 331,333 (6th Cir. 1989).

28 See § 11.02[2][b] for a discussion of liability for the offer or sale of unregistered securities under § 12(a)(1)of the Securities Act. Some courts have even indicated that if the person claiming a private placementexemption cannot show that each offeree was sufficiently sophisticated to participate in a private offering, allbuyers could rescind even if the nonqualifying offerees did not actually purchase any securities. Lively v.

Hirschfeld, 440 F.2d 631 (10th Cir. 1971); see also SEC v. Murphy, 626 F.2d 633 (9th Cir. 1980); Eriksson

v. Galvin, 484 F. Supp. 1108 (S.D.N.Y. 1980).29 SEC Release No. 33-5487 (Apr. 23, 1974). This safe harbor, Rule 146 under the Securities Act, was

rescinded on adoption of Regulation D.30 SEC Release No. 33-6389 (Mar. 8, 1982).31 Regulation D under the Securities Act includes four safe harbors from registration. Two of the four, set forth

in Rule 506 of the Regulation, arise under § 4(a)(2) of the Securities Act. The other two safe harbors, set outin Rules 504 and 505, are promulgated under the exemption for small offerings in § 3(b) of the SecuritiesAct. Only the Rule 506 safe harbors are discussed here.

32 Preliminary Note 4 to Regulation D under the Securities Act. Regulation D may be relied upon for a sale byan issuer to one or more investors that involves an intermediary acting as agent for the issuer. However,Regulation D may not be relied upon for a sale to one or more investors by a dealer that purchases from anissuer as principal. In the second case, the sale by the issuer to the dealer may qualify for the Regulation Dsafe harbor and the sale by the dealer to the investors may qualify for the Rule 144A safe harbor. Thus, inprivate offerings structured on the model of public underwritten offerings ( i.e., an issuer sale to a dealer,acting as principal, followed by the dealer's separate sales to investors), the Regulation D safe harbor couldcover the issuer's sale to the dealer, but not the dealer's resales.

33 Rules 502(d) and 144(a)(3) under the Securities Act.34 Rule 502(c) under the Securities Act.35 Rules 506(b)(2)(i) and 501(e)(1)(iv) under the Securities Act. Regulation D defines "accredited investor" to

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wealthy individuals. Rule 501(a) under the Securities Act. The SEC solicited comments on the definition of"accredited investor" for natural persons (SEC Release No. 33-9416 (July 10, 2013)) and published a reportsummarizing its review of the definition in December 2015 (SEC, REPORT ON THE REVIEW OF THE DEFINITIONOF "Accredited Investor" (Dec. 18, 2015)). In the report, the staff recommended that the SEC considerseveral revisions to the definition, including (i) revising the financial thresholds above which a natural personmay qualify as an accredited investor and (ii) permitting natural persons to qualify as accredited investorsbased on indicators other than financial thresholds, including a minimum investment amount or certainprofessional credentials. To date, the SEC has not adopted any changes to the definition of accreditedinvestor.

36 Rule 506(b)(2)(ii) under the Securities Act. Like its predecessor (Rule 146), Rule 506 permits a prospectiveinvestor to be represented by one or more other persons having the appropriate degree of knowledge andsophistication. Rule 501(h) under the Securities Act.

37 Rule 502(b)(2)(i)(C) under the Securities Act. In 2010, the SEC proposed broad changes in disclosurerequirements for asset-backed securities, including private placements. SEC Release No. 33-9117 (Apr. 7,2010). Under these proposals, it would have been a condition to the exemptions under Rule 506 and Rule144A for asset-backed securities that there be an undertaking to provide specified information to investorson a continuous basis throughout the life of the securities. This would have been a substantial departurefrom existing law, since there are currently no specific information requirements for sales to accreditedinvestors under Rule 506 and only a limited requirement to provide continuous information for resales underRule 144A. After requesting additional comments (SEC Release No. 33-9244 (July 26, 2011)), the SECultimately declined to adopt the proposed changes to the rules governing private placements. SEC ReleaseNo. 33-9638 (Sept. 4, 2014).

38 Rule 502(d) under the Securities Act.39 Rule 503 under the Securities Act. Form D requires, among other things, information on the issuer (including

its directors and officers, industry group, revenues and assets), the offering (including the number ofaccredited and nonaccredited investors, minimum investment size and the jurisdictions in which solicitationoccurred) and the broker-dealers involved (including names and compensation).

40 Compliance with Rule 503 is not a condition to the availability of the exemption under Rule 506. SEC,Division of Corporation Finance, Compliance and Disclosure Interpretations, Securities Act Rules, Question257.07 (Jan. 26, 2009). Rule 507 under the Securities Act expressly provides that the Regulation Dexemptions are unavailable to an issuer that has previously been enjoined for failure to comply with Rule503, but apparently no such injunction has ever been issued. See SEC Release No. 33-8891 (Feb. 6, 2008);SEC Office of Inspector General, Regulation D Exemption Practice 10 (Mar. 31, 2009). A 2009 report of theSEC's Office of Inspector General noted that noncompliance with Rule 503 is common and that there is noeffective enforcement of the Rule. The report recommended that the SEC develop an enforcement programand consider making filing a Form D a required element of the Regulation D exemptions. SEC Office ofInspector General, Regulation D Exemption Practice (Mar. 31, 2009). In July 2013, the SEC stated thatsome issuers do not make Form D filings in Regulation D offerings because the filing of the form is not acondition to reliance on the Regulation D rules. SEC Release No. 33-9416 (July 10, 2013).

41 See Rule 506(c) under the Securities Act.42 Rule 506(c)(2)(i) under the Securities Act.43 Rule 503 under the Securities Act. The SEC has proposed to revise Form D to require certain additional

disclosure items, some of which would apply to all Regulation D offerings and some of which would applyonly to Rule 506(c) offerings. The most notable of the proposed changes would require issuers relying onRule 506(c) to disclose (a) the methods of general solicitation used, (b) the methods used to verifyaccredited investor status of the purchasers and (c) the persons directly or indirectly controlling the issuer.SEC Release No. 33-9416 (July 10, 2013). To date, these proposed changes to Form D have not beenadopted.

44 SEC Release No. 33-9415 (July 10, 2013).


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45 SEC Release No. 33-9415 (July 10, 2013).46 Rule 506(b) under the Securities Act.47 See Rule 506(c) under the Securities Act.48 Rule 506(c)(2)(ii) under the Securities Act.49 SEC Release No. 33-9415 (July 10, 2013), 78 Fed. Reg. 44,771, 44,778 (July 24, 2013).50 SEC Release No. 33-9415 (July 10, 2013).51 Rule 506(c)(2)(ii) under the Securities Act.52 Rule 506(c)(2)(ii)(A) under the Securities Act. The verification requirement is met if the issuer reviews

specified IRS forms showing the requisite income level for the two most recent years and obtains a writtenrepresentation from the potential investor that he or she has a reasonable expectation of reaching therequisite income level during the current year.

53 Rule 506(c)(2)(ii)(B) under the Securities Act. The verification requirement is met if the issuer reviewsspecified types of documentation of the potential investor's net worth and obtains a written representationfrom the potential investor that all liabilities necessary to make a determination of net worth have beendisclosed.

54 Rule 506(c)(2)(ii)(C) under the Securities Act. The third party may be a broker-dealer, an investmentadviser, an attorney or a certified public accountant. On June 23, 2014, SIFMA issued guidance toregistered broker-dealers and investment advisers on some verification methods they could use to complywith the requirements of the safe harbor method designated for them with respect to purchasers who arenatural persons as well as on some verification methods they could use to determine whether certain legalentities qualify as accredited investors. See SIFMA, SIFMA Guidance on Rule 506(c) Verification (June 23,2014).

55 Rule 506(c)(2)(ii)(D) under the Securities Act. The investor must have invested in the issuer's Rule 506(b)offering prior to September 23, 2013 and continue to hold such securities.

56 Rule 506(c)(2)(ii) under the Securities Act.57 SEC Release No. 33-9414 (July 10, 2013).58 Rule 506(d) does not define what it means for an officer to be "participating in the offering." According to the

adopting release, however, participation in an offering would be more than transitory or incidentalinvolvement, and could include activities such as participation or involvement in due diligence activities,involvement in the preparation of disclosure documents and communication with the issuer, prospectiveinvestors or other offering participants. The SEC also considered, but determined not to make any changesto, the definition or coverage of promoters, noting that promoters represent a broad category of persons thatcaptures all individuals and entities that have relevant relationships with the issuer or to the offering, andthat those relationships must be analyzed on a look-through basis. SEC Release No. 33-9414 (July 10,2013).

59 SEC Release No. 33-9414 (July 10, 2013).60 The Rule delegates waiver authority to the Director of the Division of Corporation Finance and permits any

court or regulatory authority that enters an order, judgment or decree that would cause an actor to bedisqualified under the Rule to advise the SEC that, in its view, disqualification under Rule 506 should notarise as a consequence of such order, judgment or decree, and in such circumstances disqualification willnot arise. The notice provided by the court or regulatory agency can either be in the relevant order,judgment or decree or in a separate writing to the SEC or its staff. That waiver will be effective even withouta separate waiver from the SEC, if it was made before the relevant Rule 506 sale.

61 The adopting release states that issuers "should consider the totality of the offering taking into account thecircumstances of the offering, the covered persons involved in the offering and the Rule's requirements,which include specific disqualifying events and covered persons subject to those disqualifying events." Thiswill enable issuers to "determine their own methodology for a factual inquiry," which helps to promoteefficiency because it enables the issuer "to tailor its own inquiry without adherence to uniform standards that


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may not be applicable or appropriate in the context of a particular issuer or particular offering." SEC ReleaseNo. 33-9414 (July 10, 2013), 78 Fed. Reg. 44,730, 44,765 (July 24, 2013).

62 SEC Release No. 33-9414 (July 10, 2013), 78 Fed. Reg. 44,730, 44,747 (July 24, 2013).63 SEC Release No. 33-9414 (July 10, 2013).64 As an attempt to make the Regulation D safe harbors more "user friendly," the SEC adopted Rule 508,

which permits issuers to deviate in part from Regulation D without losing the benefits of the safe harbor.SEC Release No. 33-6825 (Mar. 14, 1989).

65 See supra Note 39.66 For example, the Rule 506 exemption turns on the nature and number of purchasers, not offerees, which is

a departure from the generally accepted, and still prevailing, judicial interpretation of the § 4(a)(2)exemption. Moreover, it does not limit the number of accredited investors that can participate in any offering.The view that an exempt private placement can be made to an unlimited number of large institutionalinvestors is also supported by the SEC's adoption of Rule 144A, as discussed at § 7.02[3].

67 SEC Release No. 33-9415 (July 10, 2013). The release states that "[a]n issuer relying on Section 4(a)(2)outside of the Rule 506(c) exemption will be restricted in its ability to make public communications to solicitinvestors for its offering because public advertising will continue to be incompatible with a claim ofexemption under Section 4(a)(2)." 78 Fed. Reg. 47,771, 44,774 (July 24, 2013).

68 Such activities include any advertisement, article, notice or other communication published in anynewspaper, magazine or similar media or broadcast over television or radio and any seminar or meetingwhose attendees have been invited by any general solicitation or general advertising. Rules 135c and 135eunder the Securities Act provide exemptions for certain publicity activities. See §§ 7.02[4] and 3.02[4]. In2007, the SEC proposed a new exemption within Regulation D, which would have permitted certain kinds ofadvertising in connection with an exempt offering to "large accredited investors." SEC Release No. 33-8828(Aug. 3, 2007). This proposal was never adopted.

69 See SEC Release No. 33-8828 (Aug. 3, 2007), Part II.C (interest in a private placement through a"substantial, pre-existing relationship" could mean that a prior registration statement did not constitutegeneral solicitation); Robert T. Willis, Jr., P.C. (avail. Jan. 18, 1988); Mineral Lands Research & Marketing

Corp. (avail. Dec. 4, 1985); E. F. Hutton & Co. (avail. Dec. 3, 1985); Woodtrails-Seattle, Ltd. (avail. Aug. 9,1982). But see Agristar Global Networks, Ltd. (avail. Feb. 9, 2004) ( "Agristar") (refusing to confirm that nogeneral solicitation would occur although a pre-existing relationship existed between the proposed offerorand the proposed offeree when the offeror proposed to send generic investor qualification questionnaires tocertain principals in the offeror's database who appeared likely to be accredited investors).

70 This is to establish that, based on the Ralston Purina interpretation of § 4(a)(2) described above, theinvestor does not require the protection of the registration provisions of the Securities Act. Courtsinterpreting the § 4(a)(2) exemption have emphasized the importance of prospective purchasers havingaccess to information, but have not imposed an affirmative duty on sellers to provide information toprospective purchasers. See Law of Private Placements (Non-Public Offerings) Not Entitled to Benefits of

Safe Harbors—A Report, 66 B US. LAW, 85, 100 n.82 (2010) (a Report by the Committee on FederalRegulation of Securities, ABA Section of Business Law); see also Investors Mortgage Group, Inc. (avail.Feb. 9, 1976).

71 See, e.g., the discussion of the exemption from registration under Rule 144 at § 7.04[2].72 These arrangements may include, among others, establishing a restricted depositary facility for the

securities or requiring an underwriter of the securities or a designated custodian to be the sole custodianthrough which all such securities may be held. Such measures would facilitate policing of the transferrestrictions.

73 See § 7.04[1].74 Although we are not aware of any SEC gloss on what constitutes a bona fide market, we believe 20% of

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75 The belief may be held by a bank acting as an underwriter or a placement agent, even if as a contractualmatter it does not purchase and resell the securities.

76 Nasdaq was the only such system but became a national securities exchange in 2006. See § 3.01, Note 4.The term "automated inter-dealer quotation system" does not include, for example, bid and ask quotationsappearing in the "pink sheets" of Pink Sheets LLC (formerly the National Quotation Bureau, Inc.) or the OTCBulletin Board. See SEC Release No. 34-27975 (May 1, 1990).

77 SEC Release No. 33-6806 (Oct. 25, 1988) (proposed rule); SEC Release No. 33-6862 (Apr. 23, 1990) (finalrule).

78 For purposes of § 4(a)(3), the resold securities are also not part of an unsold allotment and are deemed notto have been bona fide offered to the public.

79 Preliminary Note 7 to Rule 144A under the Securities Act.80 See § 7.04[1] for a more detailed discussion of certain documentation issues.81 SEC Release No. 33-6862 (Oct. 25, 1988).82 Indeed, § 201(a) of the JOBS Act required the SEC to amend Rule 144A to permit offers to persons other

than QIBs, including by means of general solicitation or general advertising. In response, the SEC amendedRule 144A to eliminate the references to "offers" and "offerees" in the conditions set forth in paragraph(d)(1) of the Rule. Consequently, a seller may rely on Rule 144A even if the securities were offered to non-QIBs and even if there has been general solicitation or general advertising. Sales, however, must still bemade only to QIBs. SEC Release No. 33-9415 (July 10, 2013).

83 "Qualified institutional buyer" is defined in Rule 144A(a)(1) under the Securities Act.84 Rule 144A(a)(1)(i)(H) under the Securities Act. Certain other forms of corporate organization may also be

treated as qualified institutional buyers—for example, the SEC staff has advised that limited liabilitycompanies meeting the $100 million threshold may be deemed to have QIB status. The SEC staff has alsoinformally expressed the view that municipalities organized as corporations (such as New York City) may betreated as QIBs, while unincorporated states (such as New York State), or municipalities as such, may not.See also Alaska Permanent Fund (avail. July 14, 2011) (large sovereign wealth investment fund with uniqueform of organization may be treated as a QIB).

84.1 A limited partnership will be deemed a QIB if all of its limited partners are QIBs. The general partner neednot be a QIB for the limited partnership to be deemed a QIB, unless the general partner is also a limitedpartner. SEC Division of Corporation Finance Compliance and Disclosure Interpretations Question 138.10(Dec. 8, 2016).

85 A not-for-profit organization must be registered under § 501(c)(3) of the Internal Revenue Code to beeligible for purposes of Rule 144A(a)(1)(i)(H).

86 Although the SEC has not defined the term "similar business trust" for purposes of Rule 144A or theSecurities Act, we consider it reasonable, based on the distinction drawn between institutional investors andindividual investors in Rule 144A (both as adopted and amended) and on other factors, to conclude forpurposes of Rule 144A that the term "similar business trust" refers to any trust created primarily toaggregate funds of a number of investors to engage in profit-making activity, including investing in securitiesor other assets, rather than one created primarily to protect and preserve the assets of an individual or oneor more related individuals. If a trust is not established as a Massachusetts or similar business trust, in orderfor the trust to qualify as a QIB, each of its beneficiaries must be a QIB as provided in paragraph (v) below.

87 Rule 144A(a)(1)(i)(A) under the Securities Act.88 Rule 144A(a)(1)(i)(D), (E) and (F) under the Securities Act. A trust fund may not have individual accounts as

participants.89 Rule 144A(a)(1)(i)(B), (C), (G) and (I) under the Securities Act. It is also reasonable to conclude that an

unregistered investment adviser (assuming it is organized as a partnership or corporation and is not anatural person) that is acting for an unregistered investment company that is a qualified institutional buyermay purchase under Rule 144A.


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90 Rule 144A(a)(1)(ii) and (iii) under the Securities Act.90.1 An investment company that is not registered under the Investment Company Act cannot aggregate

investments by other funds that are part of its family of funds when determining its status as a QIB. SECDivision of Corporation Finance Compliance and Disclosure Interpretations Question 138.09 (Dec. 8,2016).

91 Rule 144A(a)(1)(iv) under the Securities Act.92 Rule 144A(a)(1)(vi) under the Securities Act.93 SEC Release No. 33-6862 (Apr. 23, 1990), 55 Fed. Reg. 17,933, 17,936 (Apr. 30, 1990).94 According to the release adopting Rule 144A, "foreign bank" is defined in Rule 6c-9(b)(2) and (3) under the

Investment Company Act. As a result of the SEC's rescission of Rule 6c-9 in 1991, the release should beread to refer instead to Rule 3a-6 under the Investment Company Act, which replaced Rule 6c-9. See §15.05[2]. In keeping with the less stringent financial reporting standards applicable to foreign private issuers(Item 8 of Form 20-F), net worth is to be determined as of a date not more than 18 months (as opposed to16 months) prior to the sale date. A bank's net worth currently includes the bank's perpetual preferred stock,common stock, surplus, undivided profits and capital reserves (less net unrealized loss on marketable equitysecurities) and cumulative foreign currency translation adjustments. For a U.S. thrift, net worth equals itsadjusted core capital stated in its audited balance sheet. In adopting Rule 144A, the SEC requestedcomment on the appropriateness of the net worth test, including the $25 million threshold, and whether thistest is rightly applied to foreign banks. SEC Release No. 33-6862 (Apr. 23, 1990). The test received mixedreviews. On the one hand, the Board of Governors of the Federal Reserve System preliminarily concludedthat the test does not appreciably affect the number of insured banks that would qualify to purchasesecurities under Rule 144A, see Letter from Robert S. Plotkin, Division of Banking, Board of Governors ofthe Federal Reserve System, to Linda C. Quinn, Director, SEC Division of Corporation Finance (Aug. 1,1990), and the United States League of Savings Institutions expressed support for the test, see Letter fromRenie Yoshida Grohl, United States League of Savings Institutions, to Jonathan G. Katz, Secretary, SEC(June 12, 1990). On the other hand, private banking associations objected to the test as unfairlydiscriminating against banks, see Letter from Anthony T. Cluff, Association of Reserve City Bankers, toJonathan G. Katz, Secretary, SEC (June 14, 1990). No commenters addressed the application of the test toforeign banks.

95 Rule 144A(a)(1)(v) under the Securities Act.96 SEC Release No. 33-6963 (Oct. 22, 1992).97 SEC Release No. 33-6963 (Oct. 22, 1992).97.1 SEC Division of Corporation Finance Compliance and Disclosure Interpretations Questions 138.05 and

138.06 (Dec. 8, 2016).98 The SEC staff has declined to take the position that the only type of arrangement to be excluded as a loan

participation is that in which a participating bank is not in privity with the borrower but instead relies on anoriginal lender to underwrite, administer and enforce the loan, although it has confirmed that generally, if aninstrument would be subject to registration under the Securities Act, absent an exemption, it may becounted in determining the status of a buyer under the Rule. Unum Life Insurance Company (avail. Nov. 21,1990). The SEC staff has often said that "pass-through" securities will not be deemed to be loanparticipations.

98.1 SEC Division of Corporation Finance Compliance and Disclosure Interpretations Questions 138.07 and138.08 (Dec. 8, 2016).

98.2 Rule 144(a)(2) under the Securities Act.98.3 Rule 144(a)(1)(ii) under the Securities Act.99 Rule 144A(d)(1) under the Securities Act. Acceptable means are (i) a certificate of the chief financial or

other executive officer of the prospective purchaser that specifies the amount of securities that it owned andinvested on a discretionary basis on a specific date on or since the close of the prospective purchaser's


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most recent fiscal year, (ii) the most recent publicly available financial statements of the prospectivepurchaser, (iii) the most recent publicly available information appearing in documents filed by theprospective purchaser with the SEC or another U.S. or foreign governmental agency or self-regulatoryorganization and (iv) the most recent publicly available information appearing in a recognized securitiesmanual, in each case if the information is provided as of a date (16 months or, in the case of a foreignpurchaser, 18 months prior to sale under the Rule) otherwise required by the Rule. However, arepresentation or certificate of a prospective purchaser claiming that it is a qualified institutional buyer,without more, is not sufficient in the view of the SEC staff.

100 See CommScan, LLC (avail. Feb. 3, 1999) (sellers may rely on the QIB List maintained by CommScan(now Dealogic)); Communicator Inc. (avail. Sept. 20, 2002) (broker-dealers may rely on the QIB Listmaintained by Communicator in a joint venture with eight leading broker-dealers).

101 SEC Release No. 33-6839 (July 11, 1989) (reproposing Rule 144A for public comment).102 Rule 144A(d)(3)(ii) under the Securities Act. See § 15.06 for a discussion of issues raised in connection

with U.S. private placements of securities by companies that are investment companies, including closed-end investment companies, whose securities are technically eligible for Rule144A. Private offerings ofinvestment company securities are subject to restrictions that go beyond those applicable under theSecurities Act.

103 Rule 144A(d)(3) under the Securities Act. The staff of the SEC has also confirmed that securities areeligible for resale under Rule 144A if they are received, without any payment by holders, upon conversionof convertible securities that are themselves eligible for resale under the Rule. Debevoise & Plimpton (avail.July 23, 1990). Based on a similar analysis, securities of an issuer obtainable upon the cashless exercise ofwarrants issued by the same issuer should be eligible for resale under Rule 144A, provided that thewarrants themselves are eligible for resale under Rule 144A . Cf. Rule 144(d)(3)(x); SEC Release No. 33-8869 (Dec. 6, 2007); SEC, Division of Corporation Finance, Compliance and Disclosure Interpretations,Securities Act Rules, Question 132.11 (Jan. 26, 2009) (where equity securities of an issuer are acquiredupon "cashless" exercise of warrants or options, the holding period for the equity securities may be "tacked"to the holding period of the warrants or options, except in the case of cashless exercise of employee stockoptions).

104 Rule 144A(d)(3)(i) under the Securities Act.105 SEC Release No. 33-6839 (July 19, 1989); SEC Release No. 33-6862 (Apr. 23, 1990).106 See § 10.06 for a general discussion of mandatorily exchangeable securities.107 SEC Release No. 33-6862 (Apr. 23, 1990).108 See, e.g., §§ 12(g)(5), 15(d) and 16 of the Exchange Act. In the release adopting Rule 144A, the SEC

expressed its intention to interpret Rule 144A's "fungibility" requirement in the case of equity securities in amanner consistent with its practice under § 12(g)(5) of the Exchange Act.

109 Louis Loss, FUNDAMENTALS OF SECURITIES REGULATION 642–43 (6th ed. 2011).110 See, e.g., Jevic Transportation, Inc. (avail. Apr. 20, 1999); Bear, Stearns & Co. (avail. Aug. 2, 1982); Cal-

West Real Estate Fund (avail. Oct. 15, 1979); Cal-American Income Property Fund II (avail. Sept. 1, 1975);Motorola, Inc. (avail. Jan. 31, 1972); see also Turner Broadcasting System, Inc. (avail. Feb. 6, 1990) (twoclasses of common stock that varied as to voting and dividend rights were separate classes for purposes of§ 16(a) of the Exchange Act); Petro-Search, Inc. (avail. July 28, 1975) (interests in separate partnershipsconstituted separate classes of securities for purposes of § 15(d) of the Exchange Act).

111 Amana Society (avail. Sept. 23, 1974); Ellerin v. Massachusetts Mutual Life Insurance Co., 270 F.2d 259(2d Cir. 1959).

112 SEC Release No. 33-6862 (Apr. 23, 1990), 55 Fed. Reg. 17,933, 17,935 (Apr. 30, 1990). In this respect,the SEC deviated from the position it has taken from time to time with respect to the broad reach ofExchange Act reporting requirements. See, e.g., Ellerin v. Massachusetts Mutual Life Insurance Co., 270F.2d 259 (2d Cir. 1959) (where the SEC urged treatment of two series of preferred stock as a single class


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of securities for purposes of § 16 of the Exchange Act).113 SEC Release No. 33-6862 (Apr. 23, 1990), 55 Fed. Reg. 17,933, 17,935 (Apr. 30, 1990).114 SEC Release No. 33-6862 (Apr. 23, 1990). In view of the aim of the nonfungibility requirement, for

purposes of Rule 144A, securities are not of the same class and series if they are expected to trade asdifferent series in the secondary market. In the case of "strips," where the interest and principal payments,or the dividend and capital appreciation components, of a listed security are separated into two securities, aquestion is raised as to the fungibility of the new instruments with the underlying security. In light of thepurpose of the Rule 144A fungibility requirement, the "strips" should not be considered fungible since theycan be expected to have substantially different trading patterns from the listed security.

115 The exemption under Rule 12g3-2(b) is discussed in § 4.02[3][a][iv].116 Schedule B to the Securities Act is available for the registration of securities of a foreign government, as

defined in Rule 405 under the Securities Act. The definition includes the government of a foreign country ora political subdivision of a foreign country, and Schedule B is also used to register securities of an agencyor instrumentality of a foreign government that are fully and unconditionally guaranteed by that government.See § 3.05[1].

117 See Homestake Mining Company (avail. Aug. 28, 1998); British Aerospace Public Limited Company (avail.May 9, 1990). The SEC has also taken this position where an entity guarantees all of the obligations of itswholly owned subsidiary under warrants issued by the subsidiary and exercisable for securities of theguarantor. Schering-Plough Corp. (avail. Nov. 21, 1991). According to informal SEC advice, an agreementbetween an issuer and, for example, its parent whereby the parent agrees to provide funds or net worthnecessary for the issuer to make payment (a so-called "keepwell" or "support" agreement) will not betreated as the functional equivalent of a guarantee for these purposes and, accordingly, a subsidiarybenefiting from such an agreement must comply with Rule 144A(d)(4) in connection with its issuance ofRule 144A securities.

118 The SEC did not specify in adopting Rule 144A whether the required information must be provided inEnglish. It ought to be the case, however, that no special translations or English language versions of theinformation need be provided if not otherwise available. First, the premise of Rule 144A is that qualifiedinstitutional buyers have sufficient sophistication and economic clout to fend for themselves—including,presumably, by reviewing disclosure in a foreign language or requiring the issuer to provide Englishsummaries of any information not already in English. Second, in the context of Rule 12g3-2(b) under theExchange Act (discussed at § 4.02[3][a][iv]), the SEC has expressly addressed the translation issue byspecifying cases in which translations or English language summaries or versions are required. The SECcould have, but did not, include a similar requirement in Rule 144A. Thus, it would appear that the Rule'sinformation delivery requirement may be met using foreign language documents. Certainly no more than anEnglish language summary of the documents should be required. The staff of the SEC has in any eventstated that it will not respond to inquiries concerning the adequacy of information proposed to be suppliedpursuant to Rule 144A(d)(4). SEC Release No. 33-6862 (Apr. 23, 1990). Nevertheless, the SEC staff hasstated, in the case of securities issued by a company and its principal subsidiary and guaranteed by twoother groups of subsidiaries, that compliance with the Rule 144A(d)(4) requirements regarding financialstatement presentation may be satisfied by aggregate presentation of financial results for each of the twogroups. CEMEX, S.A. (avail. May 7, 1992).

119 Rule 144A(d)(4)(ii)(C) under the Securities Act. For U.S. issuers, by contrast, the balance sheet must be asof a date less than 16 months before the date of resale, and the statements of profit and loss and retainedearnings must relate to the 12-month period preceding the date of the balance sheet. If the balance sheet isnot as of a date less than six months before the date of resale, it must be accompanied by additionalstatements of profit and loss and retained earnings for the period from the date of the balance sheet to adate less than six months prior to the resale date. Rule 144A(d)(4)(ii)(A) under the Securities Act. Finally,the description of the issuer's business must be as of a date within 12 months prior to the resale date. Rule144A(d)(4)(ii)(B) under the Securities Act.


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120 See Separate Statement of Commissioner Fleischman, SEC Release No. 33-6862 (Apr. 23, 1990); see

also Preliminary Note 1 to Rule 144A under the Securities Act ( "This section relates solely to theapplication of Section 5 of the [Securities] Act and not to the antifraud or other provisions of the federalsecurities laws."). When Rule 144A was adopted, it was widely assumed that purchasers in a privateplacement also had a remedy under § 12(a)(2) of the Securities Act, although Gustafson v. Alloyd Co., 513U.S. 561 (1995), later held otherwise. See § 11.04[1].

121 See § 11.04.122 Similar questions arise with respect to information presented in a "Management's Discussion and Analysis"

section in a registration statement or report, see § 4.06, and with respect to communications with financialanalysts, see § 4.10[4].

123 Under § 12(g) of the Exchange Act, a foreign private issuer that has 2,000 or more holders of record (or500 or more holders of record who are not accredited investors) of a class of equity securities and morethan $10 million in total assets, and 300 or more U.S. resident holders at the end of its most recentlycompleted fiscal year, must register that class under the Exchange Act unless an exemption is available.Exchange Act registration requires a company to comply with SEC reporting requirements and with theSarbanes-Oxley Act. However, an automatic exemption is available under Rule 12g3-2(b) under theExchange Act, which exempts a non-U.S. company that has not listed or publicly offered securities in theUnited States from Exchange Act registration provided such company complies with the criteria under Rule12g3-2(b). SEC Release No. 33-10075 (May 3, 2016). The criteria for the exemption under Rule 12g3-2(b)are discussed in § 7.02[3].

124 The information made public to meet the conditions for the Rule 12g3-2(b) exemption may still be subject tothe antifraud provisions of § 10(b) of the Exchange Act and Rule 10b-5 thereunder.

125 See Form F-6, General Instruction I.A; § 3.04[1][b].126 Rule 144A(d)(2) under the Securities Act. In 2010, the SEC proposed broad changes to the disclosure

requirements for asset-backed securities, including private placements. SEC Release No. 33-9117 (Apr. 7,2010). Under these proposals, an issuer would have been required to file with the SEC a notice of a Rule144A offering of asset-backed securities providing specified information to investors. Rule 144A has nototherwise required any public notice. After requesting additional comments (SEC Release No. 33-9244(July 26, 2011)), the SEC ultimately declined to adopt the proposed changes to the rules governing privateplacements. SEC Release No. 33-9638 (Sept. 4, 2014).

127 For a discussion of undocumented offerings, see § 13.06.128 A sample legend might read "Sale Relying on Rule 144A—Restricted Security."129 See supra Notes 67 and 68. See also text accompanying Notes 147–155 for a discussion of general

solicitation and general advertising in the context of private offerings through the Internet.130 A tombstone advertisement issued upon completion of a traditional private placement may also constitute a

solicitation if, for example, the offering was part of an ongoing program. Alma Securities Corp. (avail. Aug.2, 1982).

131 Rule 135c(a) under the Securities Act.132 In the case of rights or exchange offerings, or offerings to the employees of the issuer or its affiliates,

certain additional information may be provided. Rule 135c(a)(3) under the Securities Act.133 Rule 135c(d) also requires an issuer that is exempt under Rule 12g3-2(b) to furnish any Rule 135c notice to

the SEC "in accordance with the provisions of that exemptive section," but Rule 12g3-2(b) was amended in2008 to eliminate the submission of documentation to the SEC. SEC Release No. 34-58465 (Sept. 5,2008).

134 SEC Release No. 33-7470 (Oct. 10, 1997).135 Note to paragraph (a)(1) of Rule 135e under the Securities Act. See § 4.05[4] for further discussion of Rule

135e.136 As discussed below in § 7.09, for non-SEC-reporting issuers in Rule 144A offerings, U.S. state "blue sky"© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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laws also may inhibit the full use of the flexibility provided under the revised rules.137 The SEC's proposal to require a Form D filing in advance of the first use of general solicitation, if adopted,

could affect the timing of these press releases in Rule 506(c) offerings.138 Issuers subject to Regulation FD will also have to consider the implications of any communications or

disclosures of material nonpublic information they make as part of general solicitation materials. See §3.02[3][c] for a discussion of Regulation FD. Form 8-K and Form 6-K filings designed to ensure publicdissemination of material nonpublic information included in an offering circular for a Rule 144A or Rule506(c) offering can now include the offering circular as an exhibit rather than including a summary of thespecific material information without referencing the offering, as had been the practice to comply withRegulation FD before the elimination of restrictions on general solicitation and general advertising inconnection with these types of offerings. However, liability concerns about expanding the scope of potentialliability to secondary market participants for the entire contents of the offering circular may still favor theprevious practice.

139 [Reserved.]140 These kinds of services will need to consider a variety of issues, including whether they will be required to

register as a broker-dealer under the Exchange Act.141 Rules 138(b) and 139(c) under the Securities Act; see SEC Release No. 33-8591 (July 19, 2005). The safe

harbors are not available for an offering under Regulation D (but are no longer necessary in connection witha Rule 506(c) offering) or § 4(a)(2).

142 See § 3.02[2][c] for a full discussion of Rules 138 and 139. See § 14.07[5] for a discussion of FINRA rulesapplicable to broker-dealer research practices.

143 See §§ 3.02[2] and 3.02[2][d] for a discussion of research in the context of a registered offering. Asdiscussed in § 3.02[2][d], underwriters' practices concerning pre-deal research are influenced not only byregulatory issues, but also by the prospect that the content of research reports could be a potential sourceof liability. (Liability for a research report is not covered by indemnification from the issuer in a standardpurchase agreement.) Based mainly on this concern, market participants have historically imposed ablackout period on pre-deal research for a limited period prior to the launch of marketing for the offering inorder to be in a position to argue that the research reports should be viewed separately from the prospects,and underwriters also often agree to other restrictions such as limiting the scope of projections.

144 See § 14.07[5][b] for a discussion of the Global Research Settlement. See also FINRA Rules 2241 (forequity research) and 2242 (for debt research), FINRA MANUAL. Some banks avoided the distribution of pre-deal research in the United States for liability reasons even before the settlement. The research practices ofinternational investment banks concerning pre-deal research still vary, based on differing views of theconcerns discussed in the text above and in Note 143 supra, but in a given offering the underwriters oftenagree on a set of procedures to avoid divergent approaches. The SEC clarified that the provisions of theJOBS Act liberalizing the publication of research about "emerging growth companies" do not amend ormodify the Global Research Settlement. See SEC, Division of Trading and Markets, Jumpstart OurBusiness Startup Act—Frequently Asked Questions [( "FAQs")] About Research Analysts and Underwriters(Aug. 22, 2012), SEC Trading and Markets FAQs, FAQ2. Any investment bank currently subject to theGlobal Research Settlement therefore cannot take advantage of any relevant JOBS Act provision withoutfirst seeking amendment or modification of the Global Research Settlement from the court overseeing itsapplication, and the SEC could support or oppose a requested modification. Although the SEC hasindicated that the Global Research Settlement may also be modified through an SEC, FINRA or NYSE rulethat specifically states an intent to supersede it, there is no evidence that such future rulemaking is likely.

145 The SEC has addressed the difference between investment banking personnel "arranging" forcommunication between research analysts and investors—conduct permitted by the JOBS Act inconnection with an emerging growth company IPO—and "directing" research analysts to communicate withprospective clients or engage in other sales efforts—conduct prohibited by existing FINRA/NASD andNYSE rules. Permissible "arranging" includes an investment banker sending an analyst a list of clients to


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contact, provided the analyst retains the discretion to decide whether to do so, and an investment bankerarranging a call between an analyst and a client, provided the investment banker does not participate insuch call. SEC Trading and Markets FAQs, FAQ 3 (Aug. 22, 2012).

146 In a registered offering, this kind of activity is limited by a number of considerations: the prohibition under §5(c) of the Securities Act on making offers before a registration statement is filed; the conditions on relianceon the safe harbors from § 5(c) provided by Rule 163 (for a well-known seasoned issuer) and Rule 163Aunder the Securities Act; and the requirement (in an IPO) under the Instructions to Item 501(b)(3) ofRegulation s -K to provide a price range in any preliminary prospectus that is "circulated." See §§ 3.02[2][a]and [b].

147 See § 7.02[1] and [2] for a discussion of the requirements for valid private offerings conducted in relianceon § 4(a)(2) of the Securities Act or Regulation D thereunder and § 7.02[3] for a discussion of therequirements for valid private offerings conducted pursuant to Rule 144A. As discussed above, theprohibition on general solicitation and general advertising no longer applies in offerings under Rule 506(c)of Regulation D and Rule 144A.

148 See § 7.02[4].149 Cf. § 3.02[2][v][A] for a discussion of publicity with respect to the Internet in the context of a public offering.150 See § 3.02[2][v][A]. This approval is relevant only for issuers who are not conducting a Rule 144A or Rule

506(c) offering, for which general solicitation ( via the Internet or any other medium) is not prohibited.151 See Net Roadshow, Inc. (avail. Jan. 30, 1998); Net Roadshow, Inc. (avail. Sept. 8, 1997).152 Net Roadshow, Inc. (avail. Jan. 30, 1998).153 See § 3.02[2][c][iii], therein and the accompanying text for a discussion of standard market practice

regarding the taping of live road shows.154 SEC Release No. 33-7516 (Mar. 23, 1998). The SEC subsequently emphasized the importance of

restricting access from the United States or by U.S. persons, as appropriate, to web-posted offshoreoffering materials for offshore offerings conducted in conjunction with a U.S. private placement.

155 See Chapter 3, Note 237 therein for a discussion of the variety of electronic "gateposts" that can be used torestrict access to an Internet website. Where the offering materials posted on the website appear inEnglish, it would be prudent to employ the more restrictive of these gateposts. Even where the postedoffering materials are not in English, it may be prudent to employ more restrictive mechanisms, where, forinstance, there is reason to believe a large expatriate community resident in the United States may seek toinvest in securities issued by a company in their home jurisdiction.

156 See § 3.02[3][ix]. Some companies have conducted their own offerings on the Internet. These have tendedto be issuers with small capitalizations that have used the Internet to raise fairly small sums, typicallywithout the assistance of established underwriters. However, most issuers and established underwriters donot show signs of moving substantially away from traditional offering practices relying on paper-baseddisclosure, and most are using the Internet only supplementally.

157 Consideration must also be given to compliance with the broker-dealer registration requirements of theExchange Act in connection with the use of the Internet to disseminate disclosure documents. See § 14.03.

158 See § 3.02[3][c][i].159 See § 7.02[4].160 Rule 502(a) under the Securities Act. In 2007, the SEC proposed to reduce the time frame for the Rule

502(a) integration safe harbor to 90 days, but it has never acted on the proposal. SEC Release No. 33-8828 (Aug. 3, 2007). The Note to Rule 502(a) also describes five factors to be considered in determiningwhether offers and sales should be integrated: (i) whether the sales are part of a single plan of financing, (ii)whether the sales involve issuance of the same class of securities, (iii) whether the sales have been madeat or about the same time, (iv) whether the same type of consideration is being received and (v) whetherthe sales are made for the same general purpose.

161 Recent guidance from the SEC confirmed that a Rule 506(c) offering can follow a Rule 506(b) offering,© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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within six months of the Rule 506(b) offering (six months being the Rule 502(a) time-based thresholdotherwise applicable to determine that two Regulation D offerings should not be integrated), andnotwithstanding the five factors set forth in Rule 502(a) as being indicative of whether two offerings withinsix months of each other should be integrated. SEC Division of Corporation Finance Compliance andDisclosure Interpretations Question 256.34 (Nov. 17, 2016).In practice, this means an issuer can, forexample, raise capital today from a number of investors with whom it has a previously existing relationship,under Rule 506(b) and without the need to take reasonable steps to verify the accredited investor status ofthose investors (so long as it "reasonably believes" they are accredited investors, as Rule 506(b) requires).Once all sales under that Rule 506(b) offering are completed, the issuer can then immediately do aseparate offering under Rule 506(c) to raise additional capital by using general solicitation to find additionalinvestors. The issuer would then have to take reasonable steps to verify accredited investor status of theinvestors only in the second (Rule 506(c)) offering. Earlier integration guidance from the SEC in 2015addressed the combinations of Rule 506 offerings with each of Regulation A (SEC Release No. 33-9741(Mar. 25, 2015)), proposed amendments to Rule 147 under the Securities Act (SEC Release No. 33-9973(Oct. 30, 2015) (final rule)) and Regulation Crowdfunding (SEC Release No. 33-9974 (Oct. 30, 2015) (finalrule)) but did not address the combination of consecutive offerings under Rules 506(b) and 506(c) (or viceversa).

162 The SEC's integration doctrine concerns "the determination as to whether separate sales of securities arepart of the same offering ( i.e., are considered ‘integrated’)." SEC Release No. 33-6863 (Apr. 24, 1990), 55Fed. Reg. 18,306, 18,322 (May 2, 1990). The question of integration originally arose with respect towhether two or more otherwise exempt offerings should be treated as a single offering to determinewhether an exemption is available. The SEC has addressed integration of exempt offerings in, inter alia:Rule 502(a) under the Securities Act (safe harbor from integration for Regulation D offerings) andPreliminary Note 7 to Regulation s (no integration of private domestic offerings with offshore sales underRegulation s); see also § 7.02[2].

163 Black Box Inc. (avail. June 26, 1990); Quad City Holdings, Inc. (avail. Apr. 8, 1993).164 Black Box Inc. (avail. June 26, 1990) (noting, however, that, if the issuer were to renegotiate the purchase

agreements following the filing of the registration statement, the renegotiated placement might constitute anew offering and thus render this "completion" interpretation of the rule inapplicable). Thus, transactions inwhich investors agree to purchase securities in private offerings but condition closing on the availability ofan effective resale registration statement (so-called "PIPE" transactions) are permitted under this Black Box

Inc. interpretation of Rule 152, so long as the investors' commitments are subject only to conditions beyondtheir control and there is no renegotiation of the terms of the purchase after the filing of the registrationstatement. However, if there are any commitments made by investors after such filing to purchase privatelythe securities to which the registration statement relates, Rule 152 would be unavailable, the privateoffering could be integrated with the public offering deemed to have commenced with the filing of theregistration statement, and the solicitation of the pre-filing commitments could be deemed to constitute anillegal public offer.

165 Privatization of the United States Enrichment Corp. (avail. May 13, 1998) (expressing the staff's view thatunregistered offers to sell securities in connection with a possible merger or acquisition transaction, if madepursuant to a valid private placement exemption, need not be integrated with a subsequent initial publicoffering commenced by the filing of a registration statement after such possible merger or acquisitiontransaction has been abandoned).

166 Squadron, Ellenoff, Pleasant & Lehrer (avail. Feb. 28, 1992). Although the SEC staff is understood to haveintended the restrictions in the Squadron letter to apply to both offerees and purchasers, we believeapplying the restrictions to offerees is unduly restrictive and inconsistent with Regulation D 's focus onpurchasers alone.

167 In taking this position, the SEC nevertheless distinguishes between a registration statement filed withrespect to a specific issue of securities and a shelf registration statement. In the latter case, because theregistration statement covers securities the final terms of which will not be determined until a "takedown" is


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effected, no general solicitation occurs upon the mere filing of the registration statement. See SEC ReleaseNo. 33-7606 (Nov. 3, 1998), as amended, SEC Release No. 33-7606A (Nov. 13, 1998). This concern doesnot apply in the case of a Rule 144A or Rule 506(c) offering, for which general solicitation is not prohibited.

168 SEC Release No. 33-8828 (Aug. 3, 2007); see also SEC Division of Corporation Finance, Compliance andDisclosure Interpretations, Securities Act Sections, Question No. 139.25 (Nov. 26, 2008). Although theproposal to revise Regulation D was not adopted, the guidance in the release on this topic remains salient.Again, this concern does not apply in the case of a Rule 144A or Rule 506(c) offering, for which generalsolicitation is not prohibited.

169 SEC Release No. 33-7943 (Jan. 26, 2001); see also infra Note 234. Reliance on Rule 155 is unnecessarywhere an abandoned public offering is followed by a Rule 144A or Rule 506(c) offering, for which generalsolicitation is not prohibited.

170 The SEC staff has said informally that it will not permit reliance on Rule 155(b) if an issuer with an effectiveshelf registration statement wishes to distribute, on a private basis and without filing, written material abouta proposed new securities offering and, if it is well received, convert that private placement into a shelftakedown.

171 In connection with the adoption of Rule 155, Rule 477 under the Securities Act was amended to providethat an issuer's application to withdraw an entire pre-effective registration statement will become effectiveautomatically upon filing with the SEC unless it objects within 15 days. The SEC also indicated that it wouldconsider promptly applications to withdraw effective registration statements. In addition, Rules 429 and 457under the Securities Act were amended to permit issuers to offset the filing fees paid in respect ofwithdrawn registration statements against future filing fees within the five years following their original filing.See SEC Release No. 33-7943 (Jan. 26, 2001).

172 See SEC Release No. 33-7943 (Jan. 26, 2001). The SEC staff has indicated in an informal meeting withpractitioners that the Rule 155(c) safe harbor will not be available if marketing efforts prior to abandoningthe registered public offering constitute general solicitation with respect to the subsequent private offering,even if those marketing efforts were part of a good faith effort to complete the public offering and not part ofa plan or scheme to avoid registration of the subsequent private offering. Neither the language of the Ruleitself nor the discussion of it in the adopting release suggests this additional condition. If indeed the SECcontinues to take this view, it could effectively limit the availability of the safe harbor, where there has beenmore than a quiet filing of the registration statement, to private offerings only to those with whom the issueror its underwriters have a pre-existing relationship or done in reliance on Rule 506(c) or Rule 144A.


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U.S. Regulation of the International Securities and Derivatives Markets, §7.03, DISCLOSURE AND…

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7.03, DISCLOSURE AND DUE DILIGENCE PRACTICES IN RULE 144A

OFFERINGS



Most offerings by foreign private issuers to U.S. investors are structured as private placements, generally asofferings through financial intermediaries relying on Rule 144A. The principal technical U.S. legal issues in suchan offering involve meeting U.S. regulatory requirements: ensuring that the offering is exempt from registrationunder the Securities Act; determining that the issuer is not an investment company or, if it is, ensuring that theoffering is structured to comply with the Investment Company Act; [173] determining that the offering does nothave derivative features that present issues under the Commodity Exchange Act; [174] and in the case of debtsecurities, ensuring that there is no violation of the Tax Equity and Fiscal Responsibility Act of 1982 ( "TEFRA")rules. [175] In addition to these technical issues, however, Rule 144A offerings are shaped by disclosure and duediligence practices. These practices reflect U.S. liability concerns, and they have evolved to address them, inaddition to complying with legal requirements and market practices in the issuer's home jurisdiction or in theprimary trading market for its shares. [176]

The disclosure process in a typical Rule 144A offering is similar in its broad outlines to the process in a U.S.public offering. The issuer, assisted by counsel, prepares a formal offering document, [177] which is distributed toinvestors in preliminary form for use in marketing the offering and then in final form

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after the offering has been priced. [178] The financial institutions conducting the offering, assisted by counsel,conduct a due diligence investigation prior to the commencement of marketing and update it (or "bring it down")before pricing and again at closing. Those institutions, acting as initial purchasers, [179] enter into a purchaseagreement with the issuer, in which (among other things) the issuer provides representations relating to theoffering circular and to its legal status, business and other matters, the issuer agrees to indemnify the initialpurchasers against liabilities arising from the disclosure, and the obligations of the initial purchasers areconditioned on delivery of documentation ( e.g., legal opinions and auditors' comfort letters) that supports thedue diligence. If there are selling securityholders in an equity offering, they are also parties to the purchaseagreement, and the contractual allocation of risk between selling securityholders and the issuer, throughrepresentations and indemnities, is negotiable; but the issuer is still responsible for the offering circular. There istypically a road show presentation, distinct from the offering circular but in principle consistent with it. [180]

[1] The Rule 144A Offering Circular—Form

There are many possible formats for an offering circular in a Rule 144A offering, depending on the structure ofthe offering. For example, many debt

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offerings are placed with U.S. institutional investors under Rule 144A and with non-U.S. investors under localexemptions from registration for institutional placements, so that no regulatory approval is required in anyjurisdiction. In such an offering, it is typical to prepare a single, integrated, stand-alone offering circular inEnglish. [181] Many equity offerings, on the other hand, are placed with U.S. institutional investors under Rule144A and in a concurrent public offering registered under local securities laws in the home jurisdiction, which is© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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the principal or only trading market. [182] In an equity offering of this kind, there would be (i) an offering circular foruse in the Rule 144A placement (and for use in the offering elsewhere outside the home market) and (ii) aparallel prospectus for use in the home jurisdiction. The preparation of the parallel offering documents isparticularly complex if the home jurisdiction prospectus is not in English. Practices vary widely as to whether theEnglish-language offering circular or the home-language prospectus is prepared first.

If the issuer is a reporting company in the United States, information may be incorporated by reference into aRule 144A offering circular from material filed with the SEC. This practice was at one time debated, because ofthe absence of any specific basis for it in the SEC's rules, but it has ceased to be controversial. Rule 144Aoffering circulars do not typically incorporate by reference material filed with a non-U.S. securities regulator orexchange, although they could presumably do so if the material is readily available, at least if it is in English.

Where the Rule 144A offering is part of a global offering that is primarily conducted outside the United States,the global offering document may include certain disclosure material that relates specifically to the U.S.placement. This disclosure might, for example, cover the aspects of the plan of distribution that are relevant tothe U.S. market, restrictions on resale of the privately placed securities, any related ADR program, and taxconsequences to U.S. purchasers. Alternative approaches, used less often today than in the past, include (i) asupplement (sometimes known as a "wrap-around") attached to the non-U.S. offering documentation andcontaining only the U.S. market material and (ii) a separate "U.S. version" of the offering circular for use in theUnited States, differing from the "non-U.S. version" only in including the U.S. market material.

[2] The Rule 144A Offering Circular—Content

The content of a Rule 144A offering circular is determined by a number of different factors. One of the mostimportant is marketing, because the offering

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circular serves to present the securities and the issuer in a manner that is favorable to the success of the offeringand that also responds to the expectations of institutional investors. Another is precedent, because investors andinitial purchasers tend to compare disclosure in a new offering with disclosure in similar offerings or of similarissuers.

A third factor is existing disclosure. If the issuer is subject to periodic reporting in its home country or principaltrading market, it will have existing disclosure that responds to local regulatory requirements and that is alreadybeing relied on by existing investors. If, on the other hand, it is conducting an initial public offering in its homejurisdiction concurrently with a Rule 144A offering in the United States, it will prepare disclosure for its homeregulator in accordance with that regulator's requirements. In such cases, where the issuer will providedisclosure for home-country purposes at the same time as it provides an offering circular to Rule 144A investors,there is usually consensus that the two disclosure documents should be consistent—because if they diverge, thedifferences could be used in retrospect to characterize one of them as deficient, and also because regulators inthe home jurisdiction may expect that information provided to investors in the international offering will also beprovided to investors in the home offering. Divergences do, however, arise. The home country disclosure mayinclude material that is unnecessary or confusing in the context of a Rule 144A offering, or that cannot beverified in the due diligence process, and that is consequently omitted from the Rule 144A offering circular. [183]

Conversely, the Rule 144A offering circular may include material that is considered unnecessary under homecountry practice.

In addition to these factors, practitioners have developed a broad consensus that certain items of disclosure arestandard in Rule 144A offerings. This consensus is reflected in the criteria of international financial institutions fortheir participation in a Rule 144A transaction, and in the criteria of international law firms and auditing firms fortheir participation and for their delivery of the "negative assurance" letters on disclosure that are customaryconditions precedent to closing. Ultimately all these are driven by a combination of liability concerns, reputationalconcerns, investor expectations and institutionalized best practices. For all these purposes, the touchstone is


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materiality to investors—the offeringp. 7-50p. 7-51

circular must be free of both material misstatements and omissions of material facts necessary to make thestatements made therein not misleading. Practices in SEC-registered offerings often serve as a reference point:if a particular element of disclosure would be sufficient in a U.S.-registered offering, it is presumed to besufficient in a Rule 144A offering. But other sources, including implementing regulations and practices under theEuropean Prospectus Directive, are important as well, and generally the fact that information would be disclosedin a registered public offering does not in itself require the conclusion that it must also be disclosed in a Rule144A offering.

Views about the sufficiency of disclosure evolve as market practices change. Following is a list of core elementsof disclosure in a Rule 144A offering, without which an offering circular would present challenges for aninvestment bank, an auditor or a law firm. The list includes only the principal disclosure elements that arise incommon situations.

Audited financial statements—Financial statements of the issuer, with full notes and audited by an independentauditor are included. Financial statements in Rule 144A offerings may be presented under various systems ofaccounting principles—U.S. generally accepted accounting principles ( "GAAP"), International FinancialReporting Standards ( "IFRS") or another national system. [184] The audited financial statements are generallyconsolidated. They typically cover three years, based on what would be required under SEC rules and under theEuropean Prospectus Directive and implementing regulations. [185] They are accompanied by explanatory notes,whose scope and content are governed by the applicable accounting and auditing principles. Unless the issuer isan SEC-reporting company, the standards governing the conduct of the audit are usually not the PublicCompany Accounting Oversight Board ( "PCAOB") standards that would apply in an SEC-registered offering, [186]

and auditor independence is notp. 7-51p. 7-52

usually evaluated under Regulation s -X, as it would be in an SEC-registered offering. [187] The audited financialstatements are sometimes more than 12 months old by the time the securities are sold—in other words, theoffering may be conducted in the early months of a fiscal year without audited financial statements from the mostrecently completed fiscal year.

If the issuer has not otherwise published interim financial statements, difficult questions occasionally arise as towhether they should be included, depending on the age of the audited financial statements at the time of theoffering. [188] When interim financial statements are presented, they are ordinarily not audited, and a limitedreview report of the auditor is generally not included in the offering circular. [189] An interim income statement isordinarily accompanied by the income statement for the corresponding period of the previous year.

Potentially challenging issues regarding financial statements arise when the issuer has recently made a materialacquisition, or has agreed to make one. In such a situation, financial statements of the target could obviously bevaluable for investors to understand the acquisition, but they may not be readily available or reliable. In an SEC-registered offering, detailed rules provide for the inclusion in the registration statement of separate financialstatements of the acquired (or target) company and pro forma financial information showing the effects of theacquisition, depending on how "significant" the acquisition is under a highly specific measurement rule. [190] InRule 144A offerings, these rules are of course inapplicable, and many other jurisdictions have either noapplicable regulation, or principles of uncertain application, or regulator discretion. Practitioners accordingly oftenrefer to the rules that apply in an SEC-registered offering as a first

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step in determining what financial information should be provided. [191] In some cases, the inability to providetarget financial statements or pro forma financial information makes it impossible to proceed with an offering.

MD&A or OFR—A discussion of the issuer's financial performance and its financial condition is included, and is© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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similar to the "management's discussion and analysis" ( "MD&A") or "operating and financial review" ( "OFR")required in offerings and periodic reports under SEC rules, the European Prospectus Directive and many othernational disclosure regimes. [192] The guiding principle is to present management's view of the issuer's financialperformance and financial condition, supplementing the information provided in the financial statements andnotes. The typical elements include: (i) an overview identifying key issues about the financial statements andrecent performance, (ii) a discussion of critical accounting policies, generally meaning policies that requiresignificant estimates and judgments, (iii) a detailed discussion comparing results of operations for recent annualand interim periods, with particular attention to trends and uncertainties that will affect future performance and tofactors that may affect comparability among periods, and (iv) a discussion of liquidity and capital resources, withparticular attention to liquidity, funding requirements, sources of funding, terms of outstanding debt and relatedmatters. Of these four elements, the last two are more nearly universal. Many of the specific elements of thediscussion are based on SEC requirements, although some of the specific disclosures required in SEC filings,particularly those introduced after the Sarbanes-Oxley Act of 2002, are not as common in Rule 144A offerings.[193]

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Risk factors—A discussion of the principal risks applicable to the issuer, its business and the particular securitiesis included. In its breadth, this discussion usually corresponds to practices in the U.S. public markets. Theexpression "risk factors," borrowed from SEC requirements [194] but now adopted in many other jurisdictions, isperhaps too narrow, as this discussion usually provides an extensive list of challenges facing the issuer andpotential disadvantages of investing in its securities. While there may be an argument that a particular issuer oroffering does not present significant risks, it is extremely rare for a Rule 144A offering circular to omit risk factorsaltogether.

Use of proceeds—In a primary offering (where the net proceeds will go to the issuer, as opposed to a sellingsecurityholder), disclosure about how the issuer plans to use the net proceeds of the offering is included.

Description of business—A description of the issuer's business, including strategy, operations, facilities,competitive and regulatory environment and other elements is provided. [195] The extent of this description varieswidely, depending on many factors including home-country regulatory requirements, economic sector of theissuer, familiarity with the issuer on the part of the market and investors, and marketing considerations. [196]

Some key elements of the business description, such as capital expenditure requirements, major contracts ormaterial legal proceedings, may be described under other or separate headings.

SEC rules provide specific, detailed disclosure regimes for registered offerings by issuers in certain sectors,including banking, mining, oil and gas and insurance. [197] In Rule 144A offerings by foreign private issuers inthose sectors, questions often arise as to the degree to which the offering circular should follow the SEC'sspecific disclosure requirements. If there is a well-developed alternative disclosure regime under home countrylaw that addresses the same issues—as there may be, for example, for disclosure of mineral reserves or oil

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and gas reserves—that can be sufficient. [198] Otherwise, practitioners usually agree on a package of disclosuresthat addresses the same issues as the SEC's requirements but may do so in a different way or at a lower level ofdetail.

Management and board of directors—There is a discussion of how the issuer is managed and governed,including the identity of the members of the board of directors (or similar body) and the principal executives. Aparticularly sensitive issue is arrangements for compensation of directors and especially management. Althoughregulatory requirements have become far more demanding in domestic markets around the world, and especiallyin the United States, it remains common in Rule 144A offerings to provide aggregate disclosure at a

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comparatively low level of detail. [199] Additional detail is provided if it is publicly available or it is particularly© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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material, either because of the amounts involved or the potential incentives or contingencies they create, forexample, with respect to a potential change of control.

Major shareholders—Any shareholders with a controlling or otherwise significant interest are identified, and thereis disclosure of contractual arrangements among them relating to their investment in the issuer. Practices differconcerning the threshold for disclosure of a shareholding interest. [200] In some cases, the identification of directshareholders of the issuer is simple enough, but if effective control lies with other parties that own their interestthrough the direct shareholders, more detailed disclosure relating to such other parties would be appropriate. It issometimes difficult to determine the parties that have effective control, and the issuer or such parties may bereluctant to disclose their identities, but most practitioners believe controlling interests must be disclosed wherethe information is known or reasonably available to the issuer or selling securityholders. [201]

Related-party transactions—A description of transactions or circumstances that present the possibility of conflictof interest between the issuer and its executives, directors or major shareholders is provided. This topic isfundamentally important, because of the potential that parties in a position to influence the issuer will do so to thedetriment of investors in the offering, because of the inherent importance of conflicting interests, and because inrare cases the consequences can be serious for investors and for the initial purchasers. It can be difficult toidentify and evaluate related-party transactions, but in close cases the touchstone should be the potential formaterial effects on investors and it is common to err on the side of caution. [202]

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Description of securities—There is a description of the terms of the securities and their governing instruments.For debt securities, this description is ordinarily very complete and may consist of the actual terms of thesecurities. For equity securities, it customarily consists of a description of those aspects of the issuer'sconstitutive documents that bear on the rights of equity holders.

Tax disclosure—A summary of the tax implications of investing in the securities is provided. In Rule 144Aofferings, this disclosure typically covers the laws of the United States and the issuer's home jurisdiction.

Plan of distribution—There is disclosure about the contractual arrangements between the initial purchasers andthe issuer or selling securityholders, including the terms of initial purchase, the expected terms of sale toinvestors and other matters. [203]

Transfer restrictions—A summary of the restrictions applicable to any offer, sale or transfer of the securities by aholder after closing, including deemed representations by purchasers in the offering that they acknowledge thesecurities have not been registered under the Securities Act and may only be offered, resold or transferred incompliance with the Securities Act, is provided.

[3] Due Diligence Practices

The initial purchasers in a Rule 144A offering conduct due diligence for the same reasons as underwriters in aregistered public offering—because it assists them in defending against liability and because it reduces the riskof defective disclosure. [204] Defective disclosure is harmful to the initial purchasers even when it does not lead tolitigation and liability, because if investors suffer losses they may hold the initial purchasers commerciallyresponsible, which hurts their reputation and may also entail direct costs to compensate investors.

The standard due diligence process includes discussions with the issuer's senior management, often based on awritten questionnaire, and often referred to as management or business due diligence. Sometimes thesediscussions extend to major shareholders or outside parties like important creditors or suppliers. There are alsodiscussions with the issuer's auditors. All these conversations are

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updated ( "brought down") by additional conversations shortly prior to pricing and again shortly prior to closing.

The standard due diligence process also includes review of issuer documentation, again often in response to a


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written list of requests typically prepared by counsel to the initial purchasers. For example, the review mayinclude corporate documentation, major contracts and records of the board of directors and its majorcommittees. In some cases, sensitivities about the confidentiality of documents lead issuers to restrict access tocertain documents or impose other conditions on the due diligence process, but counsel need to conclude thatany proposed restrictions will not unreasonably interfere with the access they require to provide their negativeassurance letters. The review is usually conducted mainly by counsel, often in a team including lawyers from thehome jurisdiction who are qualified to review documentation and lawyers with experience in U.S. disclosurepractices. [205]

As a supplement to the due diligence process, there is a contractual requirement that the issuer deliver variousdocuments as a condition to the obligations of the initial purchasers to close. These documents typically include,in addition to various certificates, negative assurance letters of counsel (often from more than one law firm) [206]

and a comfort letter from the auditor. Under the applicable auditing standards, delivery of a comfort letter in atransaction that is not subject to § 11 of the Securities Act is not permitted unless the recipient of the letter hasprovided the auditors with a representation letter to the effect that it has conducted a review process, or duediligence inquiry, substantially consistent with that it would conduct in a registered offering. [207] Alternatively, ifthe recipient chooses not to provide such a letter, the auditors may report on the results of applying certainagreed-upon procedures to specific financial statement line

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items; [208] under these circumstances, the auditors may not, however, provide negative assurance with respectto such items. [209]

Footnotes

173 See Chapter 14, Part A.174 See U.S. REGULATION OF THE INTERNATIONAL SECURITIES AND DERIVATIVES, TWELFTH EDITION, DERIVATIVES

MARKETS, § 2.03[4].175 See § 8.03[2].176 The liability regime under U.S. law applicable to Rule 144A and other private placements is discussed in

Chapter 11.177 The Rule 144A offering document is not ordinarily referred to as a "prospectus"—that term being reserved

for the analogous document filed with the SEC in an offering registered under the Securities Act and, inmany cases, for a disclosure document filed for regulatory purposes in a non-U.S. jurisdiction. The namesmost often used are offering circular (which is used in this Chapter 7) and offering memorandum.

178 In a Rule 144A offering, the use of preliminary and final versions of the offering document is not required forany regulatory reason (in contrast to the practice in SEC-registered offerings and in many non-U.S.jurisdictions). In a successful Rule 144A offering, the offering is fully sold before the final offering circular isprepared, so the final offering circular is not actually used in the marketing process or as a basis forinvestment decisions.

179 The financial institutions conducting a Rule 144A offering on behalf of the issuer are not typically referred toas "underwriters," even when they make a firm commitment to purchase the securities just as underwritersdo in a registered offering, because pursuant to Rule 144A they are not underwriters for purposes of thestatutory definition of the term in § 2(a)(11) of the Securities Act. They are often referred to as "initialpurchasers." For the same reason, the agreement is not typically called an "underwriting" agreement. Insome markets, the financial institutions conducting the offering do not purchase and resell the securities butrather undertake to procure purchasers, and they agree that if they fail to do so they will purchase thesecurities themselves. In other markets, the financial institutions conducting the Rule 144A placement do soas agents for the home-country underwriters. Practices of this kind may be to avoid additional stamp dutyunder applicable local law, or to accommodate local regulatory concerns.


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180 Road show presentations may be made in person or accessed via the Internet, but in either case thepresentation is not usually made available in a format that allows investors to retain it. Transactionparticipants typically seek to ensure that road show materials are consistent with the offering circular anddo not contain material information that is not in the offering circular. Initial purchasers increasingly requestthat road show materials be covered by company representation and indemnities in the purchaseagreement, especially when there is an electronic road show.

181 The offering circular, or a slightly modified version of it, may also serve as a listing prospectus for a listingon an exchange-regulated market like the Euro MTF in Luxembourg or the Global Exchange Market inIreland.

182 In both the debt and equity examples, the non-U.S. offering is, for U.S. purposes, exempt from registrationunder Regulation s.

183 Forward-looking information, such as projections or forecasts of future financial performance, presentsdifficult issues in this respect. In some jurisdictions outside the United States, it is required or customary,particularly for a company or operation that is new or still under development, to include projections thatwould be unusual in U.S. practice because of the perception that liability risk is high and conducting duediligence is difficult. Unless the information is clearly positive or inconsequential (which will rarely be thecase), excluding it from the Rule 144A offering circular might appear to be a material omission, so includingit with appropriate cautionary language and due diligence procedures may be preferable. See Chapter 11for a discussion of 10b-5 liability considerations applicable to forward-looking information.

184 In the early years of Rule 144A offerings it was common, where the financial statements were presentedunder a system other than U.S. GAAP, for the offering circular to include a discussion of significantdifferences between that system and U.S. GAAP. Such a discussion is no longer considered necessary, atleast if the system of accounting principles is reasonably well established. If it is not, the offeringparticipants would want to consider additional due diligence concerning the system of accounting principlesas well as disclosure about how it differs from U.S. GAAP or IFRS. Similar considerations might arise in thecase of a financial presentation under a variant of IFRS that does not conform fully to IFRS as adopted bythe International Accounting Standards Board ( "IASB").

185 A balance sheet as of the end of the earliest of the three years is not required under SEC rules, however, ifthat balance sheet is not required by the registrant's home jurisdiction (or any other jurisdiction whose rulesare applicable to the registrant outside the United States). If the issuer were an "emerging growthcompany," consideration could be given to including only two years of audited financial statements. See §3.02[1][c].

186 See Chapter 5 for a discussion of the standards of the U.S. PCAOB. Many non-U.S. jurisdictions require anaudit to be performed in accordance with the International Standards on Auditing ( "ISAs") promulgated bythe International Auditing and Assurance Standards Board ( "IAASB"), while others rely on auditingstandards adopted by a national auditor oversight body. An auditor's use of unfamiliar auditing standardswould be a point for additional due diligence and possibly for cautionary disclosures.

187 See Rule 2.01 of Regulation s -X (auditor independence requirements for an SEC registration statement orannual report). There is, however, a general expectation that the auditors qualify as independent undersome applicable standard, and they are ordinarily expected to confirm it in their comfort letter to the initialpurchasers. If the independence standards are unfamiliar, they would be a topic for due diligence inquiry bythe initial purchasers.

188 For an SEC registration statement of a foreign private issuer, interim financial statements are required if theaudited financial statements are more than nine months old, and if the issuer has published more recentfinancial information, that information must be reflected in the registration statement. See Form 20-F, Item8.A.5; § 4.04[4].

189 Depending on how much time has passed since the last audit, limited review may be necessary to supportthe ability of the auditor to provide, in its comfort letter to the initial purchasers, negative assurance as tochanges subsequent to the date of the last financial statements included in the offering circular. See AS §


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6101.46. Even then, however, the limited review report is not typically included in the offering circularunless it is included in home-country disclosure.

190 See § 4.04[10].191 SEC rules for a registered offering also require the inclusion in the registration statement of financial

statements of a major unconsolidated subsidiary or equity-method investee. See § 4.05[5][b]. Thesefinancial statements are not always considered necessary in a Rule 144A offering.

192 See Form 20-F, Item 5 (for an SEC registration statement or annual report of a foreign private issuer); Item303 of Regulation s -K (for an SEC registration statement or annual report of a domestic issuer); Items 9and 10 of Annex I to Commission Regulation (EC) 809/2004, as amended (the "Prospectus Regulation")(disclosures on operating and financial review and capital resources applicable to equity offerings). Theterm "MD&A" derives from the title of the disclosure under SEC rules applicable to domestic issuers; it hasnot been used since 2000 in the SEC rules governing disclosure by foreign private issuers (Form 20-Frequires instead, in Item 5, a discussion of "Operating and Financial Review and Prospects"). Lawyers andauditors often refer to SEC guidance on the content of MD&A, even though for a nonreporting issuer it hasno direct bearing on a Rule 144A offering and might be unknown to the issuer's financial reportingpersonnel. See § 4.05.

193 For example, disclosure requirements on off-balance sheet arrangements and on contractual obligationswere added to Item 5 of Form 20-F pursuant to the Sarbanes-Oxley Act but are not required by theInternational Organization of Securities Commissions ( "IOSCO") standards on which Form 20-F isotherwise based. These disclosures are often not included in Rule 144A offering circulars, particularly inequity offerings where home country requirements frequently guide the scope of disclosure.

194 See Form 20-F, Item 3.D; Item 503 of Regulation s -K; see also, e.g., Item 4 of Annex I and Item 2 of AnnexIII to the Prospectus Regulation (risk factor disclosure requirements for equity offerings).

195 Early Rule 144A offering circulars often also included disclosure about general economic and politicalconditions in the issuer's country, primarily because information about the country was considered helpfulfor marketing to U.S. investors that might not be familiar with it. This practice has become rare, as investorshave become familiar with a wide range of jurisdictions and have developed other information sources.Initial purchasers may find it challenging to conduct adequate due diligence on country disclosures, unlessthey are attributable to official sources. In this regard, the liability provisions applicable to a registeredoffering establish a lower threshold for an initial purchaser's due diligence defense where statements in aregistration statement are copied or extracted from a public official document. § 11(b)(3)(D) of theSecurities Act.

196 The SEC requirements applicable in registered offerings are in Item 4 of Form 20-F (for a foreign privateissuer) and Item 101 (as to business), Item 102 (as to property) and Item 103 (as to legal proceedings) ofRegulation s -K (for a domestic issuer). See also, e.g., Item 6 of Annex I to the Prospectus Regulation(business disclosure requirements for equity offerings).

197 See § 4.08 ; see also § 4.02[1][a].198 Some private placements involve more expansive disclosures than would be required in an SEC-registered

offering. For example, some Russian oil companies making Rule 144A offerings have provided morecomplete disclosure than their U.S.-registered counterparts in the oil and gas context. The offering circularprepared in connection with a Rule 144A private placement by Rosneft in July 2006 contained a variety ofreserves and resources data that would not otherwise have been permitted under SEC rules in place at thetime. See Rosneft, Offering Circular (July 14, 2006). Generally, the SEC had permitted oil and gascompanies, in their filings with the SEC, to disclose only proved reserves, i.e., the estimated quantities ofcrude oil, natural gas and natural gas liquids that geological and engineering data demonstrate with"reasonable certainty" to be recoverable in future years from known reservoirs under existing economic andoperating conditions. The SEC now permits additional categories of reserves to be disclosed, but still doesnot allow the disclosure of resources that are not reserves. See § 4.08[1] for a discussion of amendmentsto the SEC's rules governing disclosures about oil and gas activities that took effect for Securities Act


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registration statements filed on or after January 1, 2010. In addition, SEC guidance has indicated thatdisclosed reserves should generally include only those reserves that can be produced through the licenseexpiration date, unless there is a long and clear track record of license renewal as a matter of course. TheRosneft offering circular contained not only SEC-standard proved reserves data through expiration oflicenses, but also SEC-standard proved reserves data through the economic lives of the fields, as well asproved, probable and possible reserves data under the standards set forth by the Society of PetroleumEngineers (the "SPE"), estimates of reserves determined under the Russian reserves methodology andcrude oil and gas resources data based on standards set forth by the SPE covering both prospective andcontingent resources. See Rosneft, Offering Circular (July 14, 2006). The SEC-standard proved reservesdata through the economic lives of the fields were included in the offering circular based on the fact that,under relevant Russian law, Rosneft had a right to renew its licenses to the end of the economic lives of thefields so long as it did not violate the conditions of the license, and Rosneft's established history of successin extending various licenses. The other additional reserves and resources data were included in theRosneft offering circular following consideration, in part, of the customary scope of disclosure in theinternational market and the issuer's home market. It is our experience that disclosure of proved, probableand possible reserves data under the SPE standards has become quite standard in the international marketin connection with a Rule 144A offering. Inclusion of any other resources data in an offering documentprepared in connection with a private placement will require a case-by-case analysis of the facts andcircumstances concerning the issuer and any particular characteristics of its home market. In June 2016,the SEC proposed new rules intended to align disclosure requirements for mining properties with industryand global regulatory practices and standards. The proposed rules include more expansive disclosurerequirements relating to mining operations and mineral reserves, exploration and resources. SEC ReleaseNo. 33-10098 (June 16, 2016). See § 4.07.

199 Aggregate disclosure is permitted in an SEC registration statement or annual report of a foreign privateissuer, provided that individual information is not required in the home jurisdiction or otherwise publiclydisclosed. Form 20-F, Item 6.B. This would support the position that the absence of individual disclosures isnot per se a material omission.

200 The 5% level applicable in an SEC registration statement or annual report may serve as a threshold belowwhich an interest can generally be presumed not to be material. See Form 20-F, Item 7.A; Item 403(a) ofRegulation s -K.

201 Similarly, in some cases there are arrangements between shareholders that have an important effect oncontrol of the issuer but to which the issuer is not a party, and these should be disclosed if the informationis known or reasonably available to the issuer or selling securityholders. See Form 20-F, Item 7.A; Item403(c) of Regulation s -K. In some countries, concern for personal security may be a factor in thediscussion whether to identify an individual with a significant interest or to provide individual compensationinformation. The key issue is whether the information is material to investors, and the materiality concern isstrongest where control of the issuer is concerned and may be less strong where compensation isconcerned.

202 See Form 20-F, Item 7.B; Item 404(a) of Regulation s -K.203 See Form 20-F, Item 9.B; Item 508 of Regulation s -K. Many Rule 144A offering circulars include

disclosures derived from those included for regulatory reasons in registered offerings—for example, relatingto stabilization transactions. However, they often do not include information about initial purchasercompensation and the allocation of offering expenses that would be required in an SEC-registered offeringwhen that disclosure is determined not to be material to investors.

204 See § 11.04 for a discussion of the liability standards applicable to a Rule 144A offering under thesecurities laws. See § 3.02[6] for a discussion of due diligence practices in public offerings.

205 Practices vary widely with respect to the preparation of written reports on due diligence, depending on howinitial purchasers and their counsel balance the potential advantages of documenting a rigorous processagainst the risk that a written report will be damaging evidence in future litigation. In some cases, local


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underwriter or listing sponsor requirements will dictate whether due diligence or verification documentationwill be preserved.

206 See Negative Assurance in Securities Offerings ( 2008 Revision), 64 BUS. LAW. 395 (2009) (report of anAmerican Bar Association ( "ABA") committee on law firm negative assurance letters). While there are otherapproaches, negative assurance is commonly provided by two U.S. firms, one representing the issuer andthe other representing the initial purchasers. It is also often provided by law firms in the issuer's homejurisdiction and by in-house counsel for the issuer.

207 U.S. auditor comfort letters are governed by AS § 6101, which codifies Statement of Auditing StandardsNo. 72 and subsequent amending statements. See AS § 6101.04 (providing for a representation letter fromthe recipient in unregistered offerings). For a general discussion of comfort letters, see § 3.02[6], Note 325.

208 Reports of the results of applying agreed-upon procedures are governed by AT § 201 ( "Agreed-UponProcedures Engagements"). AT § 201 is based on Statement on Standards for Attestation Engagements( "SSAE") No. 10 (Attestation Standards: Revision and Recodification), which also withdrew SAS 75(Engagements to Apply Agreed-Upon Procedures to Specified Elements, Accounts, or Items of a FinancialStatement).

209 See § 3.02[6], Note 348, as to the meaning of the term "negative assurance." Although the negativeassurance provided through a comfort letter is based essentially on the same procedures reported on in anagreed-procedures letter, the extent to which a court may accord greater weight to a comfort letter inestablishing that the initial purchasers did not have the requisite scienter for Rule 10b-5 liability remainsuntested.


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U.S. Regulation of the International Securities and Derivatives Markets, §7.04, RESALES OF…

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7.04, RESALES OF PRIVATELY PLACED SECURITIES



While § 4(a)(2) of the Securities Act and Regulation D thereunder provide the basis for an issuer's exemptionfrom the registration requirements of the Securities Act, they do not provide an exemption from registration forinvestors to resell, publicly or privately, securities purchased in a private offering. Securities acquired from anissuer in a private placement are considered "restricted" securities, and purchasers must have their ownexemption for resale of those securities. The SEC's concept of "restricted securities" was without directfoundation in the Securities Act and was based on its view that a purchaser in a private offering thatsubsequently resold the securities in the public market could be viewed as "taking from an issuer with a view todistribution" and thus be an underwriter, in which case it had no statutory exemption from Securities Actregistration requirements under § 4(a)(1), or in the case of dealers, § 4(a)(3). Further, as noted above, one of therequirements of Regulation D is that the issuer exercise "reasonable care" to ensure that purchasers are notunderwriters of the securities in question, and the procedures used to ensure compliance with either RegulationD or § 4(a)(2) include restrictions on resales of privately sold securities. Regulation D and § 4(a)(2) do not,however, indicate what resales are permissible. One answer, as discussed above, is embodied in the safeharbor for resales to QIBs under Rule 144A. This section also addresses resales under the Rule 144 safeharbor, the § 4(1 ½) doctrine, the § 4(a)(7) safe harbor and the Regulation s safe harbor.

[1] Resale Under Rule 144A

Securities sold in a private placement can be resold pursuant to Rule 144A under the Securities Act, asdiscussed above.

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Many foreign issuers also provide for the possibility of Rule 144A resales in connection with offerings of theirsecurities under Regulation s under the Securities Act. [210] As discussed below, securities initially sold underRegulation s are effectively subject to a limitation on U.S. sales, generally 40 days from the date the offeringcommenced, as a result of the prohibition against dealer sales contained in § 4(a)(3)(A) of the Securities Act. [211]

In addition, in certain cases resales are also subject to the applicable distribution compliance period (40 days, sixmonths or one year), also referred to as a "seasoning" period, under the safe harbors of Regulation s. [212] Afterthese periods, securities sold in a Regulation s offering are generally unrestricted with two important exceptions:(i) equity securities of U.S. issuers [213] and (ii) securities that are part of an unsold allotment, for which thelimitations on U.S. sales of § 4(a)(3)(C) of the Securities Act apply. [214] However, Rule 144A provides a safeharbor for U.S. sales of eligible securities even during these periods. In cases where the underwriting or otherselling documentation does not restrict sales of the securities under Rule 144A, and the securities are otherwiseeligible for resale under Rule 144A ( i.e., the securities are not fungible with U.S. exchange-listed securities andthe information requirement is satisfied or does not apply), U.S. broker-dealers may purchase securities soldabroad under Regulation s and resell them to QIBs under the Rule, even during any applicable Regulation sdistribution compliance period and the 40-day period of § 4(a)(3)(A). Following Rule 144A sales, the securities inquestion will be "restricted" even after the expiration of any such seasoning period. [215]

The rationale underpinning the broker-dealer's ability to resell under Rule 144A securities initially sold abroadderives from the nature of the exemption© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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p. 7-60p. 7-61

provided by Rule 144A. Sales under Rule 144A do not constitute a distribution and are not subject to registrationunder the Securities Act, even during the distribution compliance period that follows a foreign offering. [216]

Under the philosophy of Rule 144A, issuer-imposed documentation and procedures to police resales by thepurchaser should not be necessary. However, since Regulation D requires the issuer to take "reasonable care"to ensure that purchasers are not underwriters—or risk strict liability under § 12(a)(1) of the Securities Act—thequestion for issuers is to what extent they need to police resales to comply with the reasonable carerequirement. Commenters on Rule 144A as originally proposed requested that the SEC amend Regulation D toprovide expressly that "reasonable care" could include sales to dealers based solely on contractual restrictionsrequiring them to resell the securities only pursuant to Rule 144A. The imposition of other restrictions to monitorsubsequent resales, such as transfer restrictions, "stop-transfer" procedures, letters from subsequent purchasersand other procedures, would then be unnecessary to establish the issuer's private offering exemption. The SECdid not, however, amend Regulation D, leaving open the question whether contractual restrictions limited to therequirement that the first round of resales be made under Rule 144A are sufficient to constitute "reasonablecare."

The SEC adopted Rule 144A on the premise that QIBs can be relied on to know the law, and the law requiresthem to have an exemption for any resale of a restricted security. The seller under Rule 144A does not policeand is not responsible for the resales by the buyer—it must only notify a buyer that the seller may be relying onthe Rule. If a seller is not responsible for the acts of its buyer, it would be anomalous to think that the issuer hasresponsibility for resales after its initial § 4(a)(2) sale; it should therefore be enough that the issuer has bycontract required that resales be made only to QIBs in compliance with Rule 144A. Under this analysis, a courtshould respect an issuer's § 4(a)(2) exemption in a case where a remote purchaser sells in violation of the Rule,and liability should be found under § 12(a)(1) only against the seller that sold without a Securities Act exemption.Moreover, if the SEC did not intend, by the very adoption of Rule 144A, to facilitate liquidity by reducingdocumentation, it is difficult to imagine a rationale for the SEC initiative in proposing the Rule at all. [217]

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Transaction practices suggest a consensus among issuers and the private securities bar that (i) an issuer has avalid exemption under § 4(a)(2) if it sells securities to investment banks that agree to resell only under Rule 144Aand in accordance with its requirements and (ii) there is no need to restrict subsequent resales by investors ortake other procedural steps. Under this approach, no investment letters from initial or subsequent investors arerequired, no transfer restrictions or "stop-transfer" provisions are imposed, and no legends on securities arenecessary. Documentation for Rule 144A offerings does generally include disclosure—under the headings"Transfer Restrictions" and/or "Notice to Investors"—stating that investors are (i) deemed to represent and agreeas to their sophistication and investigation in respect of the offering and (ii) notified that the offering is exemptfrom registration under the Securities Act, that they may only resell or otherwise transfer the restricted securitiesthey will hold under a valid exemption from registration (such as resales under Rule 144A, Rule 144 andRegulation s and, in some cases, under § 4(1 ½)), and of other matters. [218] It is also common practice to includea legend on certificated and global securities that describes the limitations on resale. [219]

One area where there is a tendency to obtain letters from investors in Rule 144A offerings, notwithstanding thegeneral practice of not obtaining such letters, involves cautionary letters in cases of issuers, especially in certainemerging markets, where special levels of sophistication and care by investors are required. Such letters havebeen used for offerings out of certain markets at certain times, such as Russia and parts of Eastern Europeduring their transition to market-based economies, where accounting standards, disclosure standards and

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the relative unavailability of information raise special issues, but where there is demand for investmentopportunities by sophisticated investors. In such letters, investors generally acknowledge their special


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sophistication in the market in question and the special accounting and disclosure issues and lack of informationinvolved, state that they have not relied on the financial institution intermediary in making their investmentdecision, represent that they have performed and relied on their own investigation and make certain otherrepresentations and undertakings. These letters are sometimes referred to as "toxic waste" letters.

A consensus among issuers and the private bar has also developed with respect to "side-by-side" offerings inwhich the participating financial institutions are permitted to resell both to QIBs under Rule 144A and to otherinvestors under § 4(1 ½). The non-QIB investors are usually limited to institutions that are accredited investorsas defined in Regulation D. In the immediate wake of Rule 144A's adoption, there was concern that, whateverthe SEC's view of the sophistication of QIBs, the introduction of the § 4(1 ½) element requires policing of allresales to ensure that the issuer has taken reasonable care to avoid a distribution. The imposition of suchprocedures on Rule 144A transactions, even if only using a short form of nondistribution letter, [220] can still leadto reduced market liquidity, and reduced attractiveness of private placements, especially for foreign issuers.

The consensus approach instead applies traditional § 4(1 ½) procedures only to the sales relying on thatexemption, thus in effect separating the transaction into two parts and giving the Rule 144A part the full benefitof the Rule on the theory that it is independent of the part proceeding under full § 4(1 ½) procedures. Transfersare permitted not only by the § 4(1 ½) purchasers to QIBs under Rule 144A but also by QIBs to other QIBs or toaccredited investors under § 4(1 ½) (with QIBs deciding for themselves what procedures to apply to documenttheir own compliance with the Securities Act in the case of subsequent transfers). In the case of side-by-sideplacements in which accredited investors purchasing in the initial placement are required by the applicabledocumentation to resell only to QIBs, thereby subjecting the entire deal to Rule 144A after all accreditedinvestors have completed their first resale, ongoing stop-transfer and other transfer restrictions on the securitiesare not necessary.

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Putting aside the legal debate as to sufficiency of procedures, the lack of uniform documentation in respect ofresale restrictions may raise practical uncertainties for a secondary market purchaser. It can be expected thatwhen an offering document is prepared, the applicable restrictions will be disclosed to the initial investors indetail. An offering document, however, is not generally made available to subsequent investors. Moreover,certificates representing securities held in "street" name or book-entry form (on which contractual transferrestrictions might be stated) are not generally available to investors. Similar factors limit the utility of a "Notice toInvestors" in the original offering document outlining contractual resale restrictions that could prohibit exempttransfers outside Rule 144A or impose procedural requirements. As a result, investors considering a resale ofrestricted securities outside Rule 144A should ascertain the scope of any applicable resale restrictions.

[2] Resale Under Rule 144

Early doctrine suggested that private placement investors were required to purchase with an intent to invest andwith no current intention to dispose of the security. [221] This doctrine gave rise to a theory that restrictedsecurities could be sold only upon a "change of circumstances" affecting the investor. [222] There was no clearindication what "change" was sufficient or that passage of time alone was enough to free restricted securities ofany applicable resale restrictions.

The SEC expressly rejected the "change of circumstances" doctrine in 1972 when it adopted Rule 144 under theSecurities Act. Rule 144 provides a nonexclusive safe harbor from the § 2(a)(11) definition of "underwriter" forresales in the U.S. public market of securities acquired in a private offering, establishing specific criteria fordetermining that a holder of such securities is not engaged in a distribution. [223] The critical element under theRule is the passage of time after acquisition of the securities from the issuer, or from an affiliate of the issuer.The other conditions for the Rule 144 safe harbor depend on whether the seller is an affiliate or a nonaffiliate ofthe issuer.

If the seller is not an affiliate of the issuer (and has not been for the three months preceding the sale), the Rule© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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provides safe harbor protection for a resalep. 7-64p. 7-65

beginning one year after acquisition of the securities, with no other conditions. [224] Where the issuer is anExchange Act-reporting company that is current in its reporting obligations, the Rule provides safe harborprotection for resale by a nonaffiliate beginning six months after acquisition of the securities, with no otherconditions. To be current for this purpose, the issuer must have been a reporting company for at least 90 daysprior to the sale and must have filed all required reports (other than on Form 8-K or Form 6-K) during the 12months (or such shorter period as it has been a reporting company) preceding the sale. [225]

If the seller is an affiliate of the issuer and acquired the securities in a private offering, [226] the same holdingperiods apply, and resales are subject to additional conditions relating to current public information, volume ofsales, manner of sale and filing of a notice with the SEC. [227] These additional requirements are summarizedbelow:

(i) If the issuer is an Exchange Act-reporting company, it must be current in its reporting obligations, asdescribed above. If it is not an

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Exchange Act-reporting company, certain information concerning the issuer must be publicly available.[228]

(ii) The seller must comply with restrictions limiting the aggregate amount of securities of the issuer soldduring the preceding three months pursuant to Rule 144 to:

(a) for equity securities, the greater of:

• 1% of the outstanding shares or other units of the class of securities as shown by themost recent report or statement published by the issuer; and

• the average weekly reported volume of trading in such securities on all nationalexchanges in the United States and/or reported through an automated quotation systemin the United States or on the consolidated tape during the four calendar weekspreceding the date of execution of the sale order or the date of notice in paragraph (iv)below; and

(b) for debt securities, the greater of the two tests described above for equity securities and 10% ofthe principal amount of the tranche [229] (or class when the securities are nonparticipatorypreferred stock) attributable to the securities sold. [230]

(iii) In the case of equity securities only, the securities must be sold in "brokers' transactions" exempt fromregistration pursuant to § 4(4) of the Securities Act, in transactions directly with a market-maker [231]

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(which is the manner of sale generally relied upon for Rule 144-complying block trades) [232] or in risklessprincipal transactions, [233] and no solicitations of orders may be made.

(iv) If sales during any three-month period exceed 5,000 shares or other units or $50,000 in sale price, anotice must be filed with the SEC.

Rule 144 includes specific "tacking" rules that address the calculation of the six-month and one-year holdingperiods in special cases, such as stock dividends and splits, convertible securities and pledges. Acquisition andresale of securities by the issuer or any of its affiliates restarts the holding periods.

Rule 144 also applies to the sale of securities that are not restricted securities when those securities are sold byan affiliate of the issuer ( i.e., "control securities"). For example, it provides a safe harbor for resale of securitiesacquired by the affiliate in the open market, in a registered offering or in an offering of securities (other than© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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equity securities of domestic issuers) exempt from Securities Act registration under Regulation s. For suchresales, no holding period is required, but resales must be conducted in accordance with the other requirementsdescribed above. The SEC, however, has taken the position that the Rule 144 safe harbor is not available forsales of securities by a wholly owned subsidiary of an issuer. [234] The SEC staff has also rejected the use of theRule 144

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safe harbor in so-called "gypsy swap" transactions. In such transactions, an issuer would arrange for anonaffiliated stockholder who either has unrestricted securities or has restricted securities eligible for resaleunder Rule 144, or an affiliated stockholder who has securities eligible for resale under Rule 144, to sell itssecurities to end investors. Through pre-arrangement, the issuer would, at or about the same time, sell anequivalent number of unregistered securities to the selling stockholder. The SEC has stated that the sharestaken by the end purchasers would be restricted securities within the meaning of Rule 144(a)(3) notwithstandingthe purported reliance on the Rule 144 safe harbor, and that the holding period for such securities would beginon the date of the acquisition from the seller. [235]

[a] Hedging Transactions

The SEC has repeatedly expressed concern regarding the effect of hedging activities designed to shift theeconomic risk of investment away from the holder of restricted securities. If a holder of restricted securities, soonafter acquiring them, enters into a derivative transaction that transfers the economic risk of owning the securitiesto another party, "[i]t becomes more difficult to conclude that the security holder … has held the security forinvestment purposes and not with a view to distribution." [236]

This concern has led the SEC to question whether Rule 144 adequately deals with hedging activities. Onespecific proposal has been to provide that hedging suspends (or "tolls") the holding period under Rule 144.Under Rule 144 as it stood prior to 1990, the Rule 144 holding period for restricted securities would be tolled ifthe securityholder maintained a short position in, or held any put or other option to dispose of, securitiesequivalent to the restricted securities. This tolling provision was eliminated in 1990 when the Rule was amendedto broaden the ability to tack the holding period of a prior holder to the holding period of the current holder. [237]

The SEC proposed in 1997 and again in 2007 to reinstitute a version of the tolling provision, but it has notadopted either proposal, in part because of the complexity of applying it to investors with complex

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positions or where holding periods of successive holders are tacked. [238] A number of other proposals to addresshedging activities were included in the 1997 proposal but not the 2007 proposal. [239]

On the other hand, industry participants have been concerned about uncertainty whether certain hedgingactivities could be viewed as distributions violating § 5 of the Securities Act. They have, for example, proposedthat the SEC adopt a specific safe harbor for certain hedging activities that would be deemed permissible underRule 144, and the SEC has declined to do so but has addressed some of these concerns in an interpretive letter.[240] Some hedging activities are widely thought to be permissible despite the absence of any confirmation fromthe SEC—for example, the widespread practice of a buyer of convertible notes in a Rule 144A private placementengaging in a short sale of equity securities corresponding to the shares into which the notes are convertible.However, where an investor purchases securities in a private placement and then engages in a short sale of acorresponding amount of the same securities, uncertainty remains as to whether the short sale should beconsidered a distribution. [241]

[3] Resale Under Section 4(1 ½)

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Rule 144 does not address the question whether and under what circumstances a purchaser in a private offeringcan sell in another private sale without waiting for the expiration of the applicable Rule 144 holding period.However, so long as the subsequent resale also is private, it would be consistent with concluding that theseller—as initial investor in the private placement—had not taken the privately placed, restricted securities fromthe issuer with a "view to distribution" and therefore was not an underwriter.

While the SEC did not provide any guidance in this area, the private bar and market participants developedmechanisms permitting limited resales from one purchaser in a private offering to another, without requiring anyparticular holding period, and dubbed the exemption "Section 4(1 ½)." [242] The exemption relies on the interplayof §§ 4(a)(1) (or for dealers, 4(a)(3)) and 4(a)(2), and it proceeds on the theory that if the seller is not anunderwriter—that is, the seller did not purchase with a view to distribution and its sale is not being made for theissuer—one of these exemptions should be available. [243]

Thus, if an investor to whom the private sale could originally have been made purchases from another investor asecurity acquired in a private offering where the new investor will be subject to the same restrictions imposed onthe original purchaser, the resale should not be a distribution and should therefore be exempt from registration.Such resales generally are permitted under the § 4(a)(1) exemption only if accompanied by (i) a legal opinionthat the transaction in question is exempt or (ii) an investment or nondistribution letter from the purchasercontaining essentially the same representations and agreements as those provided by the original purchaser,[244] or both. Restrictive legends on the securities and any stop-transfer instructions ordinarily remain in place. [245]

The continuation of these restrictions through the chain of opinions and letters required by the investment ornondistribution letter obtained from each purchaser by each seller in the chain is intended to keep therequirements of the original private offering in effect. The use by the private bar and market participants of thismethod of cascading sales restrictions is consistent with the SEC's policy of preventing public offerings ordistributions of unregistered securities

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before the end of the periods set out in Rule 144 and, in that respect, does not take advantage of a moreaggressive reading of the exemptions provided in the Securities Act. One may ask why an investor, at the end ofa chain of resales that are exempt under so-called § 4(1 ½), is not entitled to the § 4(a)(1) exemption on resale,regardless of the manner of sale or the time elapsed since its initial sale. The only argument that § 4(a)(1) is notavailable is that the selling investor is a so-called "statutory underwriter." But even if the sale in question is a"distribution," the investor at the end of a chain of resales arguably does not meet the other prong of thedefinition of underwriter—it has not taken from an issuer or sold for an issuer or participated (even indirectly) inany such undertaking within any reasonable meaning of the words. Some insurance companies and otherinvestors in private offerings have, on the basis of this argument, taken the position that when they sell asecurity, whether purchased in a public or private offering, they are entitled to rely on the § 4(a)(1) exemption.The SEC, however, has never accepted this position, and indeed its entire "restricted security" theory is basedon its assertion that any seller, however remote from the issuer, may be an underwriter if the sale is into thepublic market before the end of the periods set out in Rule 144. While this theory has, as indicated above, nodirect basis in the statute, the fact that § 4(1 ½) and the regulatory safe harbors (Rule 144, Rule 144A andRegulation s) have been almost the exclusive means of resale for securities purchased in private offeringsattests to the dominance of the SEC's view.

[4] Resale Under § 4(a)(7)

A new nonexclusive safe harbor from registration for resales in the United States came into effect in December2015 upon the signing into law of the Fixing America's Surface Transportation Act (the "FAST Act"). [246] New §4(a)(7) of the Securities Act exempts from registration certain resales of securities to accredited investors. Webelieve § 4(a)(7) was generally intended to codify existing market use of § 4(1 ½). The new exemption, likeRegulation D for private placements by issuers, provides sellers, and issuers required to police resales following


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their private placements, with certainty regarding these subjective elements for private resales, which isparticularly important for sales to natural persons.

Section 4(a)(7) includes several significant limitations that will not allow sellers to rely on it as broadly as theyhave relied on § 4(1 ½) in the past. However, § 4(a)(7) by its terms is a nonexclusive safe harbor, and webelieve market

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participants will continue to rely on § 4(1 ½) in many situations, which we discuss below.

The requirements of § 4(a)(7) [247] are as follows:

• All purchasers must be accredited investors. A seller seeking an exemption from registration under §4(a)(7) should be able to rely on the "reasonable belief" standard with respect to the determination as towhether a purchaser is an accredited investor, but the SEC has not provided guidance as to whether the"reasonable belief" standard applies in the context of § 4(a)(7).

• No general solicitation or general advertising may be used by the seller or anyone acting on the seller'sbehalf. This prohibition is limited to actions taken by the seller or anyone acting on its behalf and doesnot capture concurrent actions by the issuer, which provides confirmation that an issuer's conduct shouldnot affect a private resale by an unaffiliated seller not acting in concert with the issuer.

• For resales of securities of an issuer that is not an SEC reporting company or exempt from reportingpursuant to Rule 12g3-2(b) under the Exchange Act, the seller must deliver certain information toprospective purchasers. The required information includes, among other items, "reasonably current"financial information [248] prepared in accordance with U.S. GAAP or IFRS but which need not be auditedor reviewed. [249]

• If the seller is an affiliate of the issuer, the seller must include a brief statement regarding the nature ofthe affiliation and a statement certified by the

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seller that it has no reasonable grounds to believe the issuer is in violation of the securities laws orregulations. [250]

• The exemption may not be used if the seller or any agent being compensated for its participation in thetransaction would be disqualified under the bad actor provisions of Rule 506(d)(1) of Regulation D.

• The exemption may not be used by an issuer or a direct or indirect subsidiary of the issuer.

• The issuer must be engaged in business. The exemption may not be used for resales of securities of anissuer that is in bankruptcy or reorganization, or in formation, or that is a blank check, blind pool or shellcompany.

• The exemption cannot be used for an unsold allotment held by a broker or dealer as an underwriter.

• The exemption may only be used for securities of a class that has been authorized and outstanding forat least 90 days.

Furthermore, § 4(a)(7) expressly establishes that (i) securities sold under the exemption are "covered securities"within the meaning of § 18 of the Securities Act, and therefore state "blue sky" laws [251] are preempted forresales made in compliance with the exemption, and (ii) the exemption provided by § 4(a)(7) "shall not be theexclusive means for establishing an exemption from the registration requirements of [S]ection 5."

The new exemption under § 4(a)(7) will be particularly useful for private resales to natural person accreditedinvestors because, as discussed above, it avoids the need to assess investors' sophistication, familiarity with theissuer and ability to "fend for themselves" as required by Ralston Purina. [252] Equally important to facilitate suchsales is the preemption of "blue sky" laws provided by the exemption, because those laws are more burdensome


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for offers and sales to natural persons, even accredited investors, than to institutional investors.

For sales of securities of private companies, the information delivery requirement in § 4(a)(7) appears at firstglance to be the biggest obstacle to using the new exemption, but it generally should not be too burdensome forsellers.

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Even small companies should be able to provide the required financial information, which need not be audited orreviewed. The information requirement does make resales contingent on the issuer cooperating with the sellerby making the required information available. It is common, however, for private companies to contractuallyregulate subsequent transfers anyway, by imposing pre-approval requirements at the time of an initialinvestment. In any event, we expect the market may require an issuer in a private offering to covenant to makethe information required by § 4(a)(7) available to sellers on request, similar to the covenant to make informationavailable to a prospective investor required by Rule 144A(d)(4).

Finally, § 4(a)(7) is available to affiliates of the issuer. The exemption will therefore provide affiliates withadditional secondary market liquidity, which could be particularly valuable where there is no public market for thesecurities.

In situations other than secondary market trading in private company securities, the use of § 4(a)(7) may belimited. In light of the 90-day seasoning condition for the class of securities sought to be sold, § 4(a)(7) will notbe available for the kind of side-by-side transaction that is sometimes used, for example, by an issuer and aselling securityholder in a private placement of a newly issued class of debt or preferred stock, to expand theinvestor pool beyond QIBs to include institutional accredited investors. Nevertheless, the use of § 4(1 ½) forthose private placements has never been viewed as problematic, because those accredited investors aresophisticated and have adequate access to information about the issuer, and offers and sales to them thereforetypically do not raise any burdensome Ralston Purina (or "blue sky") concerns. The market will likely continue torely on § 4(1 ½) in these contexts.

Section 4(a)(7) will be available, but burdensome to comply with due to the information delivery requirement, forother resales to institutional investors that are traditionally made in reliance on § 4(1 ½), such as private,secondary block trades. In these cases, because § 4(a)(7) is a nonexclusive safe harbor, we believe sellers willgenerally treat the choice between § 4(1 ½) and § 4(a)(7) as issuers have historically treated the choice between§ 4(a)(2) and Regulation D. Where private offerings by issuers are limited principally to institutional investors,they generally are made under § 4(a)(2) and not Regulation D. Similarly, we believe private resales principally toinstitutional investors will generally continue to rely on § 4(1 ½) notwithstanding the availability of § 4(a)(7).

In these contexts, we do not expect law firms to change their practices regarding no-registration opinions justbecause the transactions either cannot or do not comply with § 4(a)(7).

As noted above, it is clear that a broker-dealer cannot use § 4(a)(7) to resell unsold allotments of securitiesacquired in a public offering. A question remains whether a broker-dealer can effect a firmly underwritten resale,under § 4(a)(7), of securities acquired privately from the issuer (assuming the class of securities

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has been outstanding for 90 days). [253] There is no express prohibition on this type of resale, but in contrast toRule 144A, § 4(a)(7) does not expressly permit an immediate resale by a broker-dealer following a purchasefrom an issuer. [254] Moreover, Congress may well have intended the prohibition on issuer use of the exemptionto also prohibit sales made in a planned, two-step process effectively on behalf of an issuer.

Broker-dealers will need to consider this question when deciding whether to rely on § 4(a)(7) to expand theuniverse of potential purchasers in underwritten offerings of private company equity securities, particularly tonatural person accredited investors. They also will need to consider the question in connection with reopeningsof debt and preferred stock issues, which will often meet the requirement of § 4(a)(7) that the class of securitieshave been outstanding for 90 days. Of course, broker-dealers can continue to rely on § 4(1 ½) for these types of© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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underwritten offerings so long as sales are made only to institutional accredited investors and to natural personaccredited investors that clearly meet the requirements of Ralston Purina and raise no "blue sky" concerns.

[5] Resale Outside the United States Under Regulation s

Securities sold in reliance on Rule 144A are restricted securities under the Securities Act. Regulation s,however, provides—as discussed in Chapter 8 —a safe harbor for resales of securities outside the UnitedStates, including by investors that have acquired their securities in Rule 144A or other private placementtransactions. [255] The only requirements for this safe harbor are that the seller not use directed selling efforts inthe United States and that the sale be made in an offshore transaction. [256] For purposes of this safe harbor, theoffshore transaction requirement is met if the offer is not made to a person in the United States and either thebuyer is outside the United States when the order is given (or the seller and its agent reasonably believe thebuyer is outside the United States) or the transaction takes place on one of the markets outside the UnitedStates designated by the SEC. [257] Once resold outside the United States pursuant to Rule 904

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under the Securities Act, securities issued by foreign companies generally are considered unrestricted, and maybe freely sold anywhere, including into the United States. [258]

This ability to resell restricted securities outside the United States provides perhaps the major source of liquidityfor foreign securities (particularly foreign equity securities) privately placed in the United States. For example,common equity shares of a foreign issuer with a foreign trading market that are sold in the United Statespursuant to Rule 144A (directly or in ADR form) can be resold on that foreign market. [259] A security sold in aRule 144A tranche of a foreign public offering can thus be resold into the same secondary market in which thesecurities originally sold outside the United States will trade. [260] U.S. private placement investors in foreignequity securities have essentially the same liquidity as foreign investors in those securities. [261]

Footnotes

210 For a discussion of the safe harbor provisions of Regulation s, see § 8.02.211 See supra Note 16; § 8.03.212 The one-year distribution compliance period was shortened to match the most shortened holding period for

restricted securities of reporting companies in the amendments to Rule 144. See SEC Release No. 33-8869 (Dec. 6, 2007).

213 Rule 905 under the Securities Act; see § 8.02[2].214 The SEC staff has indicated that an underwriter may resell, in compliance with Rule 144's volume and

manner of sale restrictions, an unsold allotment of securities from a public offering, provided that six monthshave elapsed since the closing of the last sale under the relevant registration statement. SEC, Division ofCorporation Finance, Compliance and Disclosure Interpretations, Securities Act Rules, Question 128.02(Jan. 26, 2009). We believe the same analysis should apply to allotment securities from offshoretransactions conducted pursuant to Regulation s.

215 See supra Notes 5–7 and accompanying text. Resales of restricted securities in the public market bynonaffiliates of the issuer may be made after six months for securities of an SEC-reporting issuer and oneyear for securities of other issuers.

216 Although the SEC has not addressed the issue, the same rationale should apply to permit § 4(1 ½) sales,which should not constitute a "distribution," during the distribution compliance period.

217 No reported case has addressed the liability of an issuer for remote sales in violation of Securities Actregistration requirements. However, the U.S. Supreme Court has narrowed the view of who may be a"seller" from that adopted by some lower courts, holding that a person does not become a "seller" forpurposes of § 12(a)(1) solely because his or her actions were a "substantial factor" in causing purchases of


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unregistered securities. Rather, there must be evidence that the person sought or received financial benefitfor himself or herself (or someone other than the purchaser) as a result of the purchaser's investment.Pinter v. Dahl, 486 U.S. 622 (1988). In In re Deutsche Telekom AG Securities Litigation, Fed. Sec. L. Rep.(CCH) ¶91,703 (S.D.N.Y. Feb. 20, 2002), the court expressed the Pinter holding as a two-prong test: to befound as a statutory seller, a person "must have either (1) passed title of the security to the plaintiff or (2)successfully solicited the purchase motivated at least in part by his own financial interest." Under this test,an issuer of Rule 144A securities would not seem to fall within either prong of the test with respect to anyremote sale because title passes from the immediate seller, not the issuer, to the purchaser in such a sale,and the issuer does not seek or receive any financial benefit from such a sale. Therefore, an issuer shouldnot be liable for sales in violation of the Securities Act by remote purchasers.

218 A qualified institutional buyer making a resale under § 4(1 ½) not prohibited by the documentation mightconsider various steps to ensure that the purchaser is in fact sophisticated and able to fend for itself and isaware of the restricted nature of the securities.

219 Until 2009, Rule 144A securities were required to be included in the PORTAL Market in order to clear inDTC. SEC Release No. 34-59384 (Feb. 11, 2009) (Order). Under pressure from the SEC, the rules of thePORTAL Market originally provided that, if a PORTAL security was issued in certificated form, eachcertificate must bear a legend to the effect that the security is restricted. SEC Release No. 34-33326 (Dec.13, 1993). The legending requirement was eliminated in 2001. SEC Release No. 34-44042 (Mar. 6, 2001).The practice of including legends has, however, continued.

220 Certain issuers have attempted to simplify the policing of resales in side-by-side offerings by requiring onlythat a transferor relying on Rule 144A so indicate by checking a box on the reverse of the security. Noadditional documentation is required. Even this has encountered resistance from intermediaries, which areconcerned about "back-office" procedures and compliance, and qualified institutional buyers, which, bytaking a broad view of the premise of Rule 144A, have objected to any procedural steps whatsoever nototherwise required by the Rule.

221 See Preliminary Note to Rule 144 under the Securities Act ( "[I]ndividual investors who are notprofessionals in the securities business also may be ‘underwriters' if they act as links in a chain oftransactions through which securities move from an issuer to the public.").

222 See, e.g., Roto American Corp. (avail. Feb. 19, 1971); Gilligan, Will & Co. v. SEC, 267 F.2d 461 (2d Cir.),cert. denied, 361 U.S. 869 (1959).

223 SEC Release No. 33-5223 (Jan. 11, 1972). The SEC has adopted major amendments to Rule 144 in 1990,1997 and 2007. SEC Release No. 33-6862 (Apr. 23, 1990); SEC Release No. 33-7390 (Feb. 20, 1997);SEC Release No. 33-8869 (Dec. 6, 2007).

224 Prior to the 2007 amendments to Rule 144, a nonaffiliate selling restricted securities under Rule 144 wassubject to a one-year holding period and to other conditions relating to current public information, volume ofsales, manner of sale and filing of Form 144; the other conditions ceased to apply after a two-year holdingperiod. For resales by nonaffiliates, the 2007 amendments reduced the holding period to six months withrespect to securities of an Exchange Act-reporting issuer and eliminated all conditions other than theholding period and, with respect to securities of an Exchange Act-reporting issuer sold after six months andbefore one year, the current public information requirement described in the text. SEC Release No. 33-8869 (Dec. 6, 2007).

225 An issuer that submits reports to the SEC voluntarily is not considered a reporting issuer for purposes ofRule 144. SEC, Division of Corporation Finance, Compliance and Disclosure Interpretations, Securities ActRules, Questions 131.07, 132.09 (Jan. 26, 2009).

226 For purposes of Rule 144, the term "affiliate" means "a person that directly, or indirectly through one ormore intermediaries, controls, or is controlled by, or is under common control with" the issuer. The term"control" is defined broadly as "the possession, direct or indirect, of the power to direct or cause thedirection of the management and policies of a person, whether through the ownership of voting securities,by contract, or otherwise." The SEC staff has declined to issue no-action letters on affiliate status because


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of its facts-and-circumstances nature, but an executive officer or director or beneficial owner of more than10% of the voting securities of the issuer are rebuttably presumed to be affiliates. Securities held byaffiliates of the issuer (whether or not the securities were acquired in a private placement or are otherwiserestricted securities) are often referred to as "control securities."

227 With respect to resales by affiliates, the 2007 amendments shortened the holding period from one year tosix months with respect to securities of an Exchange Act-reporting issuer and modified the other conditionsin several respects. SEC Release No. 33-8869 (Dec. 6, 2007).

228 The information that must be publicly available is defined (except for an insurance company) by referenceto Rule 15c2-11 under the Exchange Act, which identifies information concerning an issuer that a U.S.broker-dealer is required to maintain if it publishes quotations for that issuer's securities.

229 While the SEC has not formally defined the term "tranche," it has been used by the SEC in other contextsto mean securities with identical terms. See, e.g., Rule 902(f)(3) of Regulation s under the Securities Act( "[I]n a continuous offering of nonconvertible debt securities offered and sold in identifiable tranches, thedistribution compliance period for securities in a tranche shall commence upon completion of thedistribution of such tranche.").

230 Rule 144(e)(3)(vi) also provides that all sales of the same class of securities made by two or more affiliatesof the issuer, or other persons who have agreed to act in concert for the purpose of selling securities of anissuer, shall be aggregated during any three-month period for purposes of determining the limitation on theamount of securities that can be sold pursuant to Rule 144.

231 A "market-maker" is "any specialist permitted to act as a dealer, any dealer acting in the capacity of blockpositioner, and any dealer who, with respect to a security, holds himself out (by entering quotations in aninter-dealer communications system or otherwise) as being willing to buy and sell such security for his ownaccount on a regular or continuous basis." § 3(a)(38) of the Exchange Act.

232 See § 10.04 for a discussion of offerings on an "undocumented" basis.233 For purposes of Rule 144, "riskless principal transactions" are defined as "principal transaction[s] where,

after having received from a customer an order to buy, a broker or dealer purchases the security asprincipal in the market in order to satisfy the order to buy or, after having received from a customer an orderto sell, sells the security as principal to the market to satisfy the order to sell." Note to Rule 144(f)(1) underthe Securities Act. To be eligible for the Rule 144 safe harbor, the offsetting trades must be executed at thesame price (excluding any explicitly disclosed markup or markdown, commission equivalent or other fee),must be permitted to be reported as riskless under the rules of a self-regulatory organization and must meetall the requirements of a brokers' transaction enumerated in Rule 144(g) (except for the requirement thatthe broker does no more than execute the order to sell the securities as agent). Rule 144(f)(1)(iii) under theSecurities Act. The SEC amended Rule 144 in 2007 to permit the resale of equity securities by affiliates notonly through brokers' transactions and transactions with a market-maker but also, based on input fromcommenters, through riskless principal transactions, which it believes will help to ensure the Rule 144restrictions better reflect current trading practices and venues. The SEC also amended Rule 144(g) toexcept the posting of bid and ask quotations in alternative trading systems from the Rule's nonsolicitationprovisions. In order to comply with Rule 144, a broker may not solicit or arrange for the solicitation ofcustomers' orders to buy the securities in anticipation of, or in connection with, the transaction, subject tocertain exceptions. The posting of bid and ask quotations by a broker in an alternative trading system willnot be deemed a solicitation so long as the broker has published bona fide bid and ask quotations for thesecurity in the alternative trading system on each of the last 12 business days. Rule 144(g)(3)(iv) under theSecurities Act.

234 SEC, Division of Corporation Finance, Compliance and Disclosure Interpretations, Securities Act Rules,Interpretive Responses Regarding Particular Situations, Section 528.01 (Jan. 26, 2009).

235 SEC, Division of Corporation Finance, Compliance and Disclosure Interpretations, Securities Act Rules,Interpretive Responses Regarding Particular Situations, Section 528.08 (Jan. 26, 2009).

236 SEC Release No. 33-8813 (June 22, 2007), 72 Fed. Reg. 36,822, 36,826 (July 5, 2007) (solicitation of© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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public comments).237 SEC Release No. 33-6862 (Apr. 23, 1990) (eliminating the tolling provision in Rule 144).238 See Letter from SIFMA, International Swaps and Derivatives Association, Inc., and Managed Funds

Association to the SEC (Sept. 21, 2007).239 SEC Release No. 33-7187 (June 27, 1995) (requesting comment on whether Rule 144 should be amended

to address derivatives); SEC Release No. 33-7391 (Feb. 20, 1997) (proposals—on which the SEC neveracted—to make Rule 144 unavailable to a holder who hedges during the restricted period, to define a salefor purposes of § 5 to include specified hedging transactions, to adopt a shorter holding period during whichhedging could not occur without losing the safe harbor, and to reinstitute tolling); SEC Release No. 33-8813(June 22, 2007) (proposal to reinstitute tolling); SEC Release No. 33-8869 (Dec. 6, 2007) (determining notto reinstitute tolling).

240 See U.S. REGULATION OF THE INTERNATIONAL SECURITIES AND DERIVATIVES, TWELFTH EDITION, DERIVATIVESMARKETS, § 2.03[1], Note 42, and accompanying text for a discussion of SEC interpretive relief granted forcertain equity derivative transactions.

241 Counsel often advise that there should be a delay between the purchase of the restricted securities and theshort sale, and that, rather than cover the short position with the restricted securities, the investor should,after the Rule 144 holding period, sell the restricted securities in the open market and cover the shortposition with securities purchased in the open market (a practice referred to as "double-printing"). See SECDivision of Corporation Finance, Compliance and Disclosure Interpretations, Securities Act Rules, Question528.03 (Jan. 26, 2009). A related question is presented by "PIPE" (or private investment, public equity)transactions, in which investors agree to purchase shares in a private placement but closing is conditionedon availability of an effective resale shelf registration statement. Several courts have considered whether aPIPE investor that sells short before the registration statement is effective and covers with registeredshares after it is effective has violated § 5 of the Securities Act. SEC v. Lyon, 529 F. Supp. 2d 444(S.D.N.Y. 2008); SEC v. Berlacher, Civil Action No. 07-3800-ER, 2008 U.S. Dist. LEXIS 109246 (E.D. Pa.Jan. 23, 2008); SEC v. Mangan, No. 3: 06-CV-531, 2008 WL 3925059 (W.D.N.C. Aug. 20, 2008). Thesecourts found that there was no § 5 violation, but the question remains uncertain.

242 See supra Note 10.243 See The Section 4(1 ½) Phenomenon (arguing that notwithstanding certain judicial precedent and staff no-

action letters to the contrary, § 4(a)(1) provides the only viable statutory basis for private resales ofunregistered securities, since § 4(a)(2) is expressly limited to sales by an issuer).

244 See text accompanying supra Note 70.245 Offshore sales under Regulation s of securities of non-U.S. issuers generally would not require such

procedures. See § 7.05[4].246 Pub. L. No. 114-94, 129 Stat. 1312 (2015); see Nicolas Grabar, FAST Act Amendments to the U.S.

Securities Laws, HARVARD LAW SCHOOL FORUM ON CORPORATE GOVERNANCE AND FINANCIAL REGULATION,available at https://corpgov.law.harvard.edu/2016/01/16/fast-act-amendments-to-the-u-s-securities-laws(Jan. 16, 2016).

247 Conditions to reliance on the exemption under § 4(a)(7) are included in §§ 4(d) and 4(e) of the SecuritiesAct.

248 This financial information must include the issuer's most recent balance sheet and profit and loss statementand "similar financial statements" for the two preceding fiscal years (for which the issuer has been inoperation) and it must be "reasonably current," meaning it must include a balance sheet and correspondingprofit and loss statement as of a date and for a fiscal year ended less than 16 months prior to the sale and,if those items are not as of a date and for a period ending less than six months prior to the sale, beaccompanied by an interim balance sheet and profit and loss statement for a date and a period ending lessthan six months before the transaction date.

249 This information requirement is more burdensome than the information requirements imposed by Rule


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144A and Regulation D. First and most importantly, while the information is similar to what an issuer isrequired to make available if requested by a purchaser under Rule 144A(d)(4), § 4(a)(7) requires a seller todeliver the information to a purchaser. Section 4(a)(7) also imposes the same requirement for all issuers,while Rule 144A has a special rule for foreign private issuers, allowing them to meet the "reasonablycurrent" financial information requirement by complying with the requirements of their home country orprincipal trading market. The § 4(a)(7) information requirement is also more stringent than Regulation D,where information delivery is mandatory only for offerings that include nonaccredited investors.

250 It is not clear what duty this requirement imposes on a seller with respect to potential securities lawviolations by the issuer. By comparison, an affiliate can avoid control person liability under § 20 of theExchange Act if the person "in good faith" was unaware of issuer violations of the Exchange Act. Further,as written, the representation would extend to any violations of the securities laws or regulations (whichcould include minor violations).

251 See § 7.09.252 See § 7.02[1].253 We believe it is clear that a broker-dealer may purchase restricted securities from a nonsubsidiary affiliate

and resell them in reliance on § 4(a)(7), because the new exemption expressly permits use by suchaffiliates and there is no reason why such use could not be done indirectly via a broker-dealer.

254 In Rule 144A, it is explicit that these types of firmly underwritten back-to-back sales are permitted. See Note7 to Rule 144A and Rule 144A(e).

255 Rule 904 under the Securities Act; SEC Release No. 33-6863 (Apr. 24, 1990) (adopting Regulation s); see

§ 8.02[2].256 Additional requirements apply to resales by dealers, persons receiving selling concessions and certain

affiliates. See Rule 904 under the Securities Act. Conditions applicable to the Regulation s safe harbor arediscussed in § 8.02.

257 See Rule 902(h) under the Securities Act; § 8.02[1][a].258 As discussed in § 8.02[2], in 1998 the SEC adopted amendments to Regulation s that classify domestic

equity securities (but not the equity securities of foreign private issuers) as "restricted securities" within themeaning of Rule 144. SEC Release No. 33-7505 (Feb. 17, 1998). The amendments were adopted after theSEC staff expressed concern with alleged abuse of the safe harbor of Regulation s to sell offshore, freefrom the registration requirements of the Securities Act, securities that later return to the U.S. publicmarkets. The concern applied in particular to sales of restricted securities under Rule 904 to "wash" therestrictions off, followed by resales (or matched sales) back into the United States—especially in the caseof securities of U.S. companies trading publicly in the United States.

259 Many Rule 144A offerings of foreign equity securities have been made in ADR form or have givenpurchasers the option of purchasing ADRs or ordinary shares. In either case, a "restricted" ADR program isestablished that does not require filing a registration statement with the SEC. The original private placementsecurities sold in ADR form are deposited in that facility and the resulting ADRs are restricted securities, asare the underlying securities that the ADR represent. See § 10.05[3][b].

260 U.S. tax law limits the ability of issuers to offer or sell in the United States debt obligations in bearer form.Combined foreign offerings and U.S. private placements of debt securities sold to U.S. investors generallymust be in registered form and not be later exchangeable for bearer form securities. In the common casewhere the securities sold in a foreign offering are in bearer form, the U.S. portion of the offering is notinterchangeable with the offshore portion, and much of the liquidity advantage that the resale safe harbor ofRegulation s would otherwise provide is lost. See § 8.03[2] for a discussion of U.S. tax law restrictions onthe offer and sale of debt obligations in bearer form.

261 See § 8.02[2].


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7.05, PRIVATE OFFERINGS WITH REGISTRATION RIGHTS



The term "registration rights" refers to a practice that developed to improve the execution of a private placementby having the issuer promise investors a mechanism to resell the securities in the United States without theresale restrictions that apply to privately placed securities. One possible mechanism is a resale registrationstatement, which the issuer files after the private offering to register

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resales by the investors in the offering. The other possible mechanism is a registered exchange offer—referredto as an "A/B" exchange offer or an "Exxon Capital" exchange offer (after a leading no-action letter)—in which,following the private placement, the issuer offers securities that are materially identical to those initially issuedbut that, having been sold in a registered exchange offer, can be freely resold. [262] In either case, the issuerenters into a "registration rights agreement" with the financial institutions conducting the initial private offering, inwhich the issuer undertakes for the benefit of holders of the securities to take the necessary steps—either toestablish an effective resale registration statement, or to conduct a registered exchange offer—and generallyagrees to pay holders liquidated damages if it fails to meet specified deadlines. [263] Registration rights canimprove the attractiveness of the securities by enlarging the population of potential investors, particularly wherethe principal secondary market is expected to be in the United States. Some key market indices also require thatdebt securities include registration rights for inclusion in those indices.

[1] Registration Rights Generally

Registration rights are employed in a variety of situations where the resale restrictions applicable to privatelyplaced securities make the securities less attractive, and SEC registration is practicable eventually but notimmediately. [264] Conducting a registered offering has become substantially easier for SEC-reporting companieswith the refinement of the shelf rules and particularly the 2005 reform establishing automatic shelf registration forwell-known seasoned issuers, but there are still several situations where a Rule 144A offering, coupled withregistration rights, is used. One is where the registrant is not yet a reporting company, or the registrant or thetransaction is ineligible for shelf registration. In such cases, a private placement with registration rights can beexecuted more quickly than a registered offering. Another case is where the registrant is unable to meet somespecific requirement for an SEC-registered offering, such as (i) the presentation of the most recently availablefinancial information of an acquired company or pro forma financial statements showing the effects of anacquisition

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or disposition, [265] or (ii) for a foreign private issuer, the presentation of the required most recently availableinterim financial statements. [266]

The 2008 amendments to Rule 144 led to the development of new procedures that have replaced traditionalregistration rights techniques in some transactions. Rule 144 now permits a nonaffiliate to resell privately placedsecurities without restrictions after a one-year holding period, [267] and thus promises a mechanism forunrestricted resales that is much less cumbersome and almost as fast as under many traditional registrationrights agreements.


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Under the procedures, the privately placed securities are initially issued with a restricted Committee on UniformSecurity Identification Procedures ( "CUSIP") or an International Securities Identification Number ( "ISIN")identifier code, and the global security certificate deposited with the clearing system bears a legend setting forthtransfer restrictions. When the required holding period has expired and the issuer certifies to the trustee that thesecurities have become freely resalable by nonaffiliates, an unrestricted code (reserved at the time of issuance),which may be the Regulation s CUSIP or ISIN, replaces the restricted code and the restrictive legend is removedfrom the global security. [268] To implement the removal of the legend, the issuer must also certify to theDepository Trust Company ( "DTC") at least 15 days prior to the date of the change in CUSIP (in the case of amandatory change), or ten days (if the terms of the security allow holders the option of retaining the restrictedsecurity). [269] To inform the market of the change, Bloomberg has indicated that upon notice from issuers ortrustees, it will advise holders through its system of a corporate action

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indicating the change in CUSIP or ISIN, and also make corresponding adjustments to its screen pages. [270] Noaction from holders is required under the procedures, and there is no need for a new global note to be executed.[271]

These procedures have been more readily adopted for some types of securities than for others. In theinvestment grade debt market, A/B exchange offers remain the normal practice. Certain key market indices suchas the Barclays Capital U.S. Aggregate Bond Index still require securities to be "registered" and not merely"unrestricted" for inclusion, and investment funds may maintain similar requirements for the securities that canbe included in some or all of their portfolios. On the other hand, in the convertible debt market, most transactionshave done away with resale registration rights altogether in favor of the issuer being required to pay additionalinterest if it fails to permit delivery of unrestricted securities after a defined period. In the high-yield market,practice is varied, but there appears to be a trend toward using the new procedures, while providing investorswith contingent registration rights. [272]

[2] A/B Exchange Offers

In an "A/B" or "Exxon Capital" exchange offer, [273] the issuer of securities that have been sold in a privateplacement offers to exchange those securities for securities that are identical in all material respects. The SEChas taken the position that, for certain types of securities, the securities issued pursuant to the SEC-registeredexchange offer can be freely resold by a nonaffiliate of the issuer without registration. [274]

This SEC position permitting resale by nonaffiliates of the issuer without registration is available for debtsecurities and investment grade preferred stock that are not convertible into equity securities of a U.S. issuer(other than into preferred stock), as well as warrants or other rights to subscribe for such debt or preferred stock.[275] The SEC has also permitted foreign issuers that are not yet reporting companies under the Exchange Actwider latitude than U.S. issuers to

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make use of A/B exchange offers in connection with equity offerings. Foreign issuers have received no-actionrelief from the SEC allowing them to conduct registered A/B exchange offers of equity securities and convertibledebentures in connection with a subsequent listing or offering of equity securities. [276] This more lenient positionreflects the SEC's policy of encouraging foreign listings on U.S. public equity markets by allowing foreign issuersto take a "stepping stone" approach, by first conducting a private placement to institutional investors (usuallyaccompanied by an offshore placement under Regulation s) before pursuing a full public offering in the UnitedStates. [277] This exchange-offer structure does not appear to have been used recently, however, perhapsreflecting the general reticence of foreign companies to commit to U.S. equity listings and the accompanyingregulatory burdens.

A nonaffiliate reselling securities received in an A/B exchange offer is not required to deliver a prospectus,unless it is a broker-dealer. A broker-dealer that© Cleary Gottlieb Steen & Hamilton LLP, 2019. All rights reserved.

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receives for its own account registered securities in exchange for restricted securities must agree to deliver aprospectus meeting the requirements of the Securities Act in connection with any resales (and the prospectusand any related letter of transmittal used in the exchange offer must contain a notice to such effect). Theprospectus it delivers may be the prospectus for the exchange offer so long as it contains disclosure regardingthe plan of distribution with respect to resale transactions. The plan of distribution need not name the broker-dealer or the amount of exchange securities owned by the broker-dealer. According to the SEC staff, byagreeing to deliver or by delivering a prospectus, the broker-dealer will nevertheless not be deemed to haveadmitted that it is an "underwriter" within the meaning of the Securities Act. [278]

The structure sanctioned by these SEC staff no-action letters has been conditioned upon an agreement by theissuer to provide to the SEC a supplemental letter stating that the issuer is relying upon this no-action relief. Theletter must also include representations that the issuer has not entered into any arrangement with any person todistribute the securities to be issued in the exchange and that, to the best knowledge of the issuer, personsparticipating in the exchange are acquiring the securities in the ordinary course and have not entered into anyarrangement or understanding with anyone to participate in a distribution of the securities. [279]

The A/B exchange offer procedure offers advantages to both issuers and investors over the alternative ofgranting investors resale registration rights. First, issuers in these transactions avoid maintaining an "evergreen"resale registration statement, as is customary in the case of privately offered securities with resale registrationrights. [280] Second, from the investor's perspective there is no potential liability in connection with a resale by anexchanging holder under § 12(a)(2) of the Securities Act (unless the seller is a broker-dealer), no prospectusdelivery requirement (unless the seller is a broker-dealer) and no requirement to include the names of theholders of securities being exchanged in the registration statement.

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Standard agreements to conduct A/B exchange offers typically set deadlines for the filing and declaration ofeffectiveness of the exchange offer registration statement and the consummation of the related exchange offer.They also usually require the issuer to maintain the effectiveness of the registration statement for a specifiedperiod (often 90 to 180 days) to enable broker-dealers to comply with their prospectus delivery obligations. Theissuer must consequently consider whether any development that occurs during this period requires the filing ofa prospectus supplement or a post-effective amendment to the registration statement. [281] Any failure to complywith these deadlines typically triggers liquidated damages in the form of the obligation to pay additional intereston debt securities until the failure is cured. This consequence emphasizes the importance of assessing, inconnection with the initial private placement, whether any difficult issues are likely to arise that could delay orprevent filing or the effectiveness of the exchange offer registration statement.

[3] “Rule 144A for Life” Offerings

If, generally in the case of debt securities or non-participating preferred stock, an issuer's investor base is willingto hold restricted securities, an issuer may not be required to offer registration rights, whether via resaleregistration or a registered exchange offer. This is particularly true where an issuer does not have reportingobligations under the Exchange Act and does not wish to become a reporting issuer. Such offerings that do notprovide for registration rights are referred to as "Rule 144A for Life" offerings, and the offered securities remainunregistered and restricted for the entire period during which they remain outstanding.

Footnotes

262 A/B (or Exxon Capital) exchange offers are discussed at § 7.04[2]. A/B exchange offers are used primarilyfor nonconvertible debt securities and investment grade preferred stock. They are not permitted for otherequity securities (including convertible debt), except in limited circumstances for equity securities of a


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foreign private issuer. Resale registration statements are most frequently used for issuances of commonstock.

263 If a registered exchange offer is contemplated, debt securities in a Rule 144A placement will need to beissued pursuant to a trust indenture that meets the requirements of the Trust Indenture Act. See § 3.05[4].The same applies if a resale registration statement is used for debt securities, although this practice is lesscommon.

264 Issuers may also offer registration rights to affiliates holding control securities if so requested. See §§ 7.05and 9.05[8].

265 See § 4.04[10].266 See § 4.04[4]. In addition, securities that are convertible into U.S.-listed equity are sometimes sold in a Rule

144A private placement even where SEC registration would be available. This practice exists because, inorder to facilitate the offering, the issuer will sometimes purchase shares from the investors to mitigate thedownward pressure on the shares resulting from the offering, thereby also permitting the investors toestablish under their hedge. The issuer would not be permitted to purchase its shares under Regulation Mof the Exchange Act if the offering were done on an SEC-registered basis.

267 Under Rule 144, a nonaffiliate can resell securities of an Exchange Act-reporting issuer freely after a six-month holding period, but only if the issuer is current in its periodic reporting. If the issuer ceases to becurrent ( "goes dark"), nonaffiliates must wait one year to resell without restrictions.

268 The SEC has stated that it will not object if issuers remove restrictive legends from securities held bynonaffiliates after all of the applicable conditions in Rule 144 are satisfied, while observing that suchremovals are at the discretion of the issuer and that disputes over removals are likely to be governed bycontract and by state law, rather than federal law. See SEC Release No. 33-8869 (Dec. 6, 2007).

269 See The Depository Trust Company, DTC Important Notice 4903-09, Optional Use of the Depository TrustCompany's ( "DTC") Mandatory Exchange Platform for Rule 144A and Reg. S Securities that have becomeunrestricted securities (Apr. 1, 2009). Similar actions would need to be taken if the securities are held in adifferent clearing system.

270 SIFMA, SIFMA Guidance: Procedures, Covenants, and Remedies in Light of Revised Rule 144 (Oct. 2008).271 In the case of optional resales where an issuer has not undergone procedures to provide for free

transferability of the entire tranche of securities, a holder may need to submit a certificate of transfer.272 See Adam E. Fleisher & Jung W. Ju, Revised Rule 144 and Registration Rights, Market Practice Two

Years On, PRACTICAL LAW, THE JOURNAL (Feb. 2010).273 Exxon Capital Holdings Corp. (avail. May 13, 1988).274 See Shearman & Sterling (avail. July 2, 1993), Morgan Stanley & Co. Inc. (avail. June 5, 1991) ( "Morgan

Stanley") and letters cited therein.275 The SEC has offered no rationale to explain why preferred stock should be rated investment grade to

qualify for relief, whereas debt securities are not subject to any rating requirement. Some exceptions fromthe rating requirement have been granted, see K-III Communications Corp. (avail. May 14, 1993)(permitting the use of a registered exchange offer in connection with unrated preferred stock convertibleinto debt securities of the issuer), but the SEC staff has informally advised that K-III Communications

should not be viewed as an extension of Morgan Stanley or its progeny since the preferred stock at issuewas in the staff's view the functional equivalent of debt. (It remains to be seen whether the removal in July2011 of references to credit ratings in Securities Act rules and forms pursuant to § 939A of the Dodd-FrankAct, see SEC Release No. 33-9245 (July 27, 2011), will affect the SEC's position on this issue.) The SECalso suggested in a subsequent no-action letter that the availability of the exchange offer procedure maydepend upon characteristics of the privately placed security, including, among others, whether it is moreattractive to qualified institutional buyers and institutional accredited investors and, accordingly, has beensold to them rather than to "retail" investors, whether the security is listed on a national securities exchangeand whether it pays distributions semi-annually rather than monthly or quarterly. See Brown & Wood LLP


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(avail. Feb. 7, 1997). Again, the staff offered no rationale for why those characteristics are significant.276 Grupo Financiero InverMexico, S.A. (avail. Apr. 4, 1995) (granting no-action relief in connection with an

exchange offer of convertible debentures in connection with a registered offering or listing of capital stock ofthe issuer); Corimon C.A. S.A.C.A. (avail. Mar. 22, 1993) (granting no-action relief in connection with anexchange offer of ADRs in connection with the listing of similar ADRs); Transportación Maritima Mexicana,

S.A. de C.V. (avail. June 8, 1992) (granting no-action relief in connection with an exchange offer of ADRs tobe conducted concurrently with a global offering outside Mexico, including a registered U.S. offering, ofunits consisting in part of similar ADRs); Vitro, Sociedad Anónima (avail. Nov. 19, 1991) (granting no-actionrelief in connection with an exchange offer of ADRs to be conducted concurrently with a global offering ofcommon shares, including a registered U.S. offering of ADRs representing common shares). CertainSchedule B issuers have relied on the Exxon Capital no-action letters (see, e.g., Corporación Andina deFomento (SEC File Nos. 333-90296 and 333-88404, filed June 6, 2002, and May 10, 2002, respectively)and Republic of Peru (SEC File No. 333-98403, filed Aug. 19, 2002).

277 It is not clear, however, that the SEC staff would permit a foreign issuer of equity securities to conduct anA/B exchange offer if its obligation to conduct the exchange offer were not also contingent on a subsequentpublic offering or listing in the United States. See Adam E. Fleisher, David E. Webb & MaliniMukhopadhyay, THE MECHANICS OF A/B EXCHANGE OFFERS (Practical Law Company, 2010).

278 Shearman & Sterling (avail. July 2, 1993). The SEC has also stated its view that the initial purchasers in theprivate placement would not normally be considered "underwriters" of the subsequent registered exchangeoffer or bear liability under § 11 or § 12(a)(2) of the Securities Act. See Brief of SEC as Amicus Curiae

Supporting Defendants, In re HealthSouth Securities Litigation, No. CV-03-BE-1500-S (N.D. Ala. Nov. 28,2006); see also In re Livent, 151 F. Supp. 2d 371 (S.D.N.Y. 2001).

279 See Grupo Financiero InverMexico, S.A. (avail. Apr. 4, 1995); Corimon C.A. S.A.C.A. (avail. Mar. 22, 1993);Transportación Maritima Mexicana, S.A. de C.V. (avail. June 8, 1992); Vitro, Sociedad Anónima (avail. Nov.19, 1991).

280 Agreements to conduct an A/B exchange offer do, however, typically require the filing and maintenance of aresale registration statement in certain circumstances if the exchange offer is not available to all investors(including if the initial purchasers are holding allotment securities) or if the SEC repeals its positionpermitting exchange offers.

281 An issuer eligible to use Form S-3 or F-3 is permitted to incorporate by reference into its exchange offerregistration statement any current Exchange Act report filed on Forms 8-K or 6-K (as applicable) after theeffective date of the registration statement. An issuer filing on Form S-1 or F-1, however, may onlyincorporate by reference past, rather than future, Exchange Act reports—as a result, such an issuer may berequired to file a post-effective amendment to its registration statement in order to reflect any materialdevelopment arising after the initial effective date. The amendment to the registration statement is subjectto SEC review (like the original registration statement itself), which can require suspending use of theregistration statement.


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7.06, PRIVATE PLACEMENT OF ADRs



Rule 144A offerings of foreign equity securities are sometimes made in ADR form or give investors the option ofpurchasing American depositary shares ( "ADSs") or ordinary shares. In either case, the issuer and thedepositary establish a "restricted" ADR program, under which privately placed shares are delivered to thedepositary, which issues ADSs that are restricted securities for

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purposes of Rule 144 under the Securities Act. The restricted ADSs are not eligible for registration on Form F-6with the SEC. [282]

In some cases, the foreign issuer may also plan to set up an "unrestricted" ADR program subsequently. Underthe unrestricted program, shares are delivered to the depositary, which issues unrestricted ADSs that areavailable for public trading, and the program is registered with the SEC on Form F-6. [283] Special issues canarise where a foreign issuer attempts to establish an unrestricted ADR facility within one year after a privateplacement, since the shares sold in the private placement are restricted securities and not yet eligible for resaleunder Rule 144, and accordingly may not be deposited in the unrestricted facility. The SEC staff has cautionedthat it may be unwilling to declare the requisite F-6 registration statement effective unless the purchasers in theprivate placement (but not subsequent transferees) have acknowledged in writing the restrictions on transfer anddeposit in an unrestricted ADR facility of the privately placed shares. Some banks have resisted issuer requeststo require such acknowledgements, arguing that the resulting administrative burden could significantly limit thenumber of potential investors in the Rule 144A offering. An issuer that accedes to these marketing concerns maynot be able to establish an unrestricted ADR facility within one year of the private placement. [284]

Special issues also may arise where a foreign issuer wishes to establish an unrestricted ADR facility immediatelyupon, or shortly after, completion of an offering outside the United States that is exempt from Securities Actregistration under Regulation s. The SEC staff has taken the position that the registration statement on Form F-6relating to the unrestricted ADSs may not be filed until the expiration of the applicable distribution complianceperiod (if any) under Regulation s or seasoning period under § 4(a)(3), whichever is longer. [285]

The SEC has also expressed concern regarding the possibility for leakage of restricted securities into the U.S.public market where an issuer proposes to sponsor concurrent restricted and unrestricted ADR programs. Theseprograms can operate as a single combined facility, under which both restricted and unrestricted securities areissued under a single deposit agreement, or as separate facilities. In such cases, the SEC staff has taken theposition, as a condition to

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effectiveness of a Form F-6, that it will require various procedures to be implemented in connection with thefacility or facilities to prevent leakage, including assigning separate CUSIP numbers to the restricted andunrestricted ADSs and obtaining written certifications acknowledging applicable transfer restrictions on therestricted ADSs or that the ADSs were obtained in an offshore transaction complying with Rule 904 ofRegulation s. [286] So-called "collapsible" facilities, which provide, upon effectiveness of the related Form F-6, forautomatic fungibility of restricted ADSs with ADSs issued out of an unrestricted facility, have also attracted SECattention. In such circumstances, the SEC staff has informally taken the position that effectiveness of the Form


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F-6 will depend upon implementation of various procedures, including obtaining written certifications on depositand withdrawal of securities with respect to the restricted ADR facility as to the status of the beneficial owner andcompliance with resale restrictions.

Footnotes

282 The ADSs are not eligible for registration because the underlying shares, having been sold in a privateplacement, do not meet the requirements of General Instruction I.A(2) of Form F-6. Restricted ADSs maybe resold under Rule 144 to the same extent the underlying restricted shares could have been. SEC,Division of Corporation Finance, Compliance and Disclosure Interpretations, Securities Act Rules 532.16(Jan. 26, 2009).

283 ADR programs of foreign issuers generally are discussed in § 3.04.284 If the unrestricted facility is to be exchange-listed, the issuer might consider conducting a registered

exchange offer of unrestricted shares for restricted shares at the time it establishes the unrestricted ADRfacility. See § 7.04[2].

285 Depositary Receipts (avail. Apr. 14, 1993).286 Depositary Receipts (avail. Apr. 14, 1993).


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7.07, CLEARANCE AND TRADING



Under the rules of the principal U.S. clearing system, The Depository Trust Company, securities that are eligiblefor resale under Rule 144A are eligible for electronic clearing and settlement through DTC. [287] In a typical Rule144A offering of debt securities or ADSs, DTC holds one or more certificates in global form evidencing theamount of securities issued. Restricted securities placed with QIBs pursuant to the § 4(a)(2) exemption may alsobe held in DTC if they meet the criteria for resale under Rule 144A. Securities sold to non-QIBs are not normallyheld in DTC, since resales of such securities are ordinarily subject to "policing" mechanisms to prevent adistribution, and DTC does not have procedures for this purpose. All Rule 144A securities deposited at DTC arerequired to bear a CUSIP or other identification number different from the number borne by any unrestrictedsecurities of the same class, including, for example, securities that were sold in a concurrent offering underRegulation s and that have "seasoned" for purposes of U.S. securities law. [288] DTC participants (brokers anddealers) trade and settle transactions electronically through book-entry trades recorded on the participants'accounts.

Euroclear and Clearstream are able to participate in DTC indirectly through their depositaries that maintain anaccount as participants in DTC. This arrangement permits trades to be made between DTC participants andparticipants in Euroclear and Clearstream.

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Many offerings use a "dual tranche" system, in which two global securities are deposited with DTC, one for theRule 144A tranche and one for the Regulation s tranche, but it is also possible for an entire issue of securitiesplaced in a global offering to be represented by one global security deposited with DTC and for transactions inthe securities to be effected worldwide using a single book-entry system; in such a case all securities are subjectto Rule 144A restrictions.

Rule 144A securities trade primarily over the counter among dealers. Transactions in Rule 144A securitiesconducted by U.S. broker-dealers are generally subject to transaction reporting requirements. [289] Attempts todevelop organized markets or trading systems for Rule 144A securities began concurrently with the adoption ofRule 144A, when the SEC approved the PORTAL Market, a system for primary and secondary trading ofsecurities pursuant to Rule 144A with facilities for clearance and settlement of both domestic and foreignsecurities through DTC, in the case of transactions effected in the United States, and Clearstream Banking, inthe case of transactions effected outside the United States. [290]

The PORTAL Market originally was a "closed" trading system, in that it required prequalification of PORTALMarket participants and imposed restrictions on a participant's ability to trade securities out of the system exceptin transactions that resulted in the delivery of an unrestricted security. The PORTAL rules were substantiallyamended in 1993 and again in 2007, each time in an effort to make PORTAL a more effective trading venue. [291]

But these measures were unsuccessful, and the PORTAL Market ultimately ceased operating in 2008. [292]

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In addition to the PORTAL Market, there have been several other attempts to develop electronic tradingplatforms for Rule 144A securities. These trading platforms have not been widely used.


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Footnotes

287 The Depository Trust Company, Operational Arrangements (Necessary for Securities to Become andRemain Eligible for DTC Services) (Jan. 2012).

288 SEC Release No. 34-33327 (Dec. 13, 1993).289 FINRA Rules, Rules 6600–6630 and 7700–7730, FINRA MANUAL. FINRA operates TRACE for reporting

and disseminating information on secondary market transactions in debt securities, which covers both SEC-registered and Rule 144A debt securities. SEC Release No. 34-43873 (Jan. 23, 2001). Trades in Rule144A equity securities are reported to the OTC Reporting Facility. On June 30, 2014, FINRA began publiclydisseminating Rule 144A corporate debt security transaction data. This data previously was not publiclydisseminated due to the prohibition on offers to non-QIBs in Rule 144A transactions. FINRA Rules, Rule6750. SEC Release No. 34-70345 (Sept. 6, 2013).

290 SEC Release No. 34-27956 (Apr. 27, 1990).291 SEC Release No. 34-33326 (Dec. 13, 1993); SEC Release No. 34-56172 (July 31, 2007). Pursuant to the

2007 amendments, Nasdaq launched an updated version of the PORTAL Market that sought to reestablishit as a closed trading system permitting qualified participants to trade PORTAL-eligible securities with oneanother through a centralized electronic quotation and trading platform. The new market establishedqualification requirements for brokers and dealers and for QIBs that wished to access PORTAL, andimplemented quotation, trade negotiation and trade reporting functions in the PORTAL Market for PORTAL-designated securities.

292 SEC Release No. 34-58638 (Sept. 24, 2008). Even though Nasdaq terminated PORTAL securitydesignation processes as of October 26, 2009, existing regulatory obligations for securities previouslydesignated as PORTAL securities were not eliminated until June 2010. SEC Release No. 34-61979 (Apr.23, 2010) (Order).


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7.08, SPECIAL CONCERNS OF BROKER-DEALERS



Private placements raise certain specific compliance issues for broker-dealers, including those discussed below.

[1] Application of Regulation T to Rule 144A Transactions

Regulation T, promulgated by the Board of Governors of the Federal Reserve System (the "Board") under § 7 ofthe Exchange Act, regulates extensions of credit by broker-dealers. [293] Under Regulation T, purchases bybroker-dealers of debt securities in a bona fide public offering are deemed not to be extensions of credit to theissuer, [294] while purchases of privately offered debt securities are deemed to be extensions of credit. [295] Whenpurchasing privately offered debt securities, therefore, broker-dealers must take steps to comply with RegulationT. [296]

To facilitate the SEC's goal in adopting Rule 144A of achieving a more liquid and efficient institutional resalemarket for unregistered securities, however, the Board has interpreted Regulation T not to treat a broker-dealer'spurchase of an unregistered debt security for resale under Rule 144A, including a purchase in the course of Rule144A market-making activities, as an extension of credit by the broker-dealer for purposes of Regulation T. [297]

The Board's interpretation is applicable to both primary and secondary market transactions.

The theory of the Board's interpretation is that, in purchasing debt securities with the intention to resell thempursuant to Rule 144A, a broker-dealer is "arranging" for an extension of credit by the purchaser of the debtsecurities in the resale transaction, rather than extending the credit itself. Regulation T permits a broker-dealer toarrange any credit provided that it does not willfully

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arrange credit that violates the Board's other margin regulations, Regulations U and X. [298] The narrow focus ofthe Board's interpretation leaves open the applicability of Regulation T in circumstances in which,notwithstanding a good faith intention when the security is purchased to resell it under Rule 144A, the broker-dealer is unable to resell it or resells it other than pursuant to Rule 144A.

In adopting its interpretation, the Board declined to accept a proposal made by the Securities IndustryAssociation that it simply declare that a broker-dealer's purchase of a security for resale—whether or notpursuant to Rule 144A—constitutes a permitted arranging rather than an extension of credit. The effect of theBoard's refusal is to leave Regulation T relevant for a broker-dealer's purchase, as principal, of privately offereddebt securities other than for resale under Rule 144A. In the context of such transactions (including, e.g., initialresales to both QIBs and to accredited investors in traditional private sales), the participating financial institutionshould consider whether it needs to obtain an appropriate representation from the issuer that the proceeds of theoffering will not be used for purchasing, carrying or trading in securities. [299]

[2] Net Capital Consequences of Rule 144A Securities

Restricted securities held by a broker-dealer have traditionally resulted in a 100% charge to its regulatory capitalbecause such securities do not have a "ready market" and "cannot be publicly offered or sold because ofstatutory, regulatory or contractual arrangements or other restrictions." [300] In the adopting

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release for Rule 144A, however, as well as in several subsequent no-action letters, the SEC and its staff haveoutlined criteria under which certain Rule 144A-eligible securities and other securities that the SEC may nototherwise deem to have a "ready market" may qualify for reduced capital charges. Application of such reducedcapital charges depends on factors such as, among other things, the rating of the securities (or the issuer) by"nationally recognized statistical rating organizations," [301] the availability of public information regarding theissuer, the issuance size and the convertibility of the securities into publicly traded securities that have a readymarket. [302]

[3] FINRA Rule 5123

Upon its effectiveness in 2012, FINRA Rule 5123 increased the disclosure and reporting obligations of certainbroker-dealers that participate in private placements. Rule 5123 generally requires FINRA members andassociated persons to provide disclosure to investors in private offerings describing the anticipated use ofoffering proceeds and the amount and type of offering expenses and offering compensation (either in the privateplacement memorandum or a separate term sheet). Rule 5123 requires FINRA members to file this disclosurewith FINRA no later than 15 days after the document is provided to investors or indicate in the filing that nowritten documents were used. [303] Because of its numerous exemptions—which include most offerings toinstitutional investors (including offerings made pursuant to Rule 144A) and offerings pursuant to Regulation sunder the Securities Act, as well as offerings of nonconvertible debt or preferred securities by issuers that meetthe eligibility criteria for incorporation by reference in Forms S-3 and F-3)—from a practical perspective the Ruleapplies mainly to private placements of securities to natural persons in the United States.

Footnotes

293 See § 14.07[6][a].294 See Fed. Res. Reg. Serv. ¶5-606.56 (staff opinion, Dec. 20, 1993) (Board staff does not regard the

purchase of debt securities offered in a public offering as an extension of credit subject to the marginregulations, with the caveat that the public offering must not be structured "so that the sale in actualpractice resembles a private placement.").

295 See Fed. Res. Reg. Serv. ¶5-606.4 (staff opinion, Dec. 11, 1984).296 Where the proceeds of the debt securities will not be used for the purpose of purchasing, carrying or trading

in securities, the broker-dealer may obtain a certification of the purpose of the credit on Board Form T-4and extend and maintain the credit on a "good faith" basis. See 12 C.F.R. § 220.6(e); see also §14.07[6][a][i]. Nonpurpose credit extended by a broker-dealer may be subject to applicable net capitalcharges. See FINRA Rules, Rule 4210(e)(7), FINRA MANUAL.

297 See Fed. Res. Reg. Serv. ¶5-470.1 (Board interp., July 16, 1990).298 See 12 C.F.R. § 220.3(g). Purchases of privately offered debt securities by nonbroker-dealers, including in

transactions under Rule 144A, are extensions of credit that may be subject to the Board's Regulation U(applicable to certain U.S. lenders other than broker-dealers) and Regulation X (applicable to certain U.S.and U.S.-controlled borrowers). For example, Regulation U limits extensions of credit to finance thepurchase or carrying of "margin stock" (such credit referred to as "purpose credit") that are secured, directlyor indirectly, by "margin stock." See 12 C.F.R. § 221.3. "Indirect" security may include, for example,restrictions on the sale, pledge or other disposition of assets where 25% or more of the assets subject tothe arrangement consist of margin stock. See 12 C.F.R. § 221.2. "Margin stock" includes, among othersecurities, stock registered on a U.S. national securities exchange (including Nasdaq) and debt convertibleinto such stock. See 12 C.F.R. § 221.2. Accordingly, a U.S. person purchasing a privately offered note(including debt of a foreign issuer) any proceeds of which are used for "purpose credit" and the collateral forwhich includes "margin stock" may be subject to Regulation U, which among other requirements would limitthe amount of credit that may be extended through the note. In addition, even where a privately placed note


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is not "purpose credit" but is directly or indirectly secured by "margin stock," Regulation U may require thepurchaser to register and make certain related filings with the Board, although the Board staff has byinterpretation created an exception from this requirement for nonpurpose credit notes purchased underRule 144A. See Fed. Res. Reg. Serv. ¶5-942.69 (staff opinion, Aug. 30, 1996).

299 See supra Note 296.300 Rule 15c3-1(c)(2)(vii) under the Exchange Act; see also § 14.07[2][b][i].301 [Reserved.]302 See SEC Release No. 33-6862 (Apr. 23, 1990); Securities Industry Association (avail. July 27, 2000);

Securities Industry Association (avail. Aug. 16, 1999); Securities Industry Association (avail. Mar. 30, 1996);Securities Industry Association (avail. June 12, 1992).

303 As of 2013 FINRA updated the form that firms must use to file offering documents and information pursuantto FINRA Rule 5123. The updated form includes six new questions that are designed to assist FINRA inprioritizing its review of private placement filings. The updated form is available on the FINRA website.


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7.09, STATE SECURITIES LAW CONCERNS



Institutional private placements of the kind discussed in this chapter are structured primarily to comply withfederal securities laws, but they may also be

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subject to state securities laws, traditionally referred to as "blue sky" laws. [304] For transactions in "coveredsecurities," as described below, federal law expressly preempts state securities laws, making them inapplicable.For other transactions, including most private placements by foreign private issuers, there is no federalpreemption of state law, and such transactions are typically conducted under exemptions from state lawregistration requirements.

The National Securities Markets Improvement Act of 1996 (the "NSMIA") [305] amended § 18 of the Securities Actto provide for federal preemption of state laws requiring registration of securities that are "covered securities" ortransactions in "covered securities," as defined in § 18. [306] Several categories of preemption are potentiallyrelevant to private placements: (i) where the securities are listed (or will be listed upon completion of thetransaction) on a national securities exchange or are senior to listed securities of the same issuer (for example,debt securities of an issuer that has listed common equity), (ii) where the transaction is exempt from registrationpursuant to regulations promulgated by the SEC under § 4(a)(2) of the Securities Act [307] and (iii) where thesecurities are exempt from registration pursuant to § 4(a)(7) of the Securities Act.

The private placement of debt or equity securities of a foreign private issuer with U.S.-listed equity falls squarelywithin the scope of federal preemption. Other Rule 144A offerings require a two-part analysis. First, the issuer'ssale of securities to the initial purchasers is typically conducted in reliance on

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§ 4(a)(2) and not on Regulation D, so it does not have the benefit of federal preemption. [308] However, all statesecurities laws provide for an exemption from state registration for offers and sales of securities to specifiedtypes of institutional investors. While the breadth of these exemptions varies from state to state, most stateshave adopted provisions similar to those contained in the various versions of the Uniform Securities Act, whichexempt offers and sales specifically to broker-dealers or more generally to institutional investors, a term definedto include registered broker-dealers. [309]

Second, a participating financial institution's resale to investors will benefit from federal preemption if thesecurities are listed or are senior to listed securities. If federal preemption does not apply to the participatingfinancial institution's resale, the placement can be conducted in most states under published interpretations oradopted statutory or regulatory provisions specifically to the effect that sales made in compliance with Rule 144Aor to QIBs will be exempt under the applicable state securities laws. [310] Sales in states without specific Rule144A or QIB exemptions may be made if the purchaser otherwise qualifies under the definition of statutorilyspecified types of institutions, which vary from state to state. [311]

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An additional concern under state "blue sky" laws arose as a result of the amendments to Rule 144A permittinggeneral solicitation. Broad-reaching general solicitation could constitute offers to noninstitutional investors—and


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only three states effectively exempt offers by nonreporting issuers to those investors in a Rule 144A context. [312]

Accordingly, use of broad-reaching general solicitation in Rule 144A offerings by nonreporting issuers [313] couldrequire registration under most state "blue sky" laws. [314]

Footnotes

304 See § 3.02[7] for a further discussion of state "blue sky" laws.305 National Securities Markets Improvement Act of 1996, Pub. L. No. 104-290, 110 Stat. 3416 (1996).306 The scope of preemption under the NSMIA also extends to state laws that prohibit, limit or impose

conditions on (i) the use of an offering document prepared by or on behalf of the issuer, (ii) proxystatements, reports and other disclosure documents filed with the SEC or (iii) offers or sales based on themerits of the offering or the issuer, in each case, in connection with transactions in "covered securities."See § 18(a) of the Securities Act.

307 State securities laws are also preempted with respect to the securities of an investment company registeredunder the Investment Company Act. Moreover, the NSMIA provides for preemption with respect to offers orsales of securities to "qualified purchasers," as defined by the SEC. The SEC has never acted to provide awidely applicable definition of "qualified purchasers" for this purpose but, in connection with amendmentsmade to Regulation A in 2015, did apply this designation to "any person to whom securities are offered orsold pursuant to a [Regulation A] Tier 2 offering." See 17 CFR 230.256. On two prior occasions, first in2001 and then in 2007, the SEC proposed but did not adopt a definition of "qualified purchasers" that wouldpreempt state securities regulations in connection with offers and sales to "accredited investors" and "largeaccredited investors," respectively, each as defined in Regulation D under the Securities Act. SEC ReleaseNo. 33-8041 (Dec. 19, 2001); SEC Release No. 33-8828 (Aug. 3, 2007) (withdrawn Oct. 1, 2009).

308 See § 7.02[2]. An issuer selling directly to investors will often do so in reliance on Rule 506 of Regulation D,rather than on § 4(2), specifically in order to have the benefit of federal preemption, particularly where theavailability of state law exemptions is uncertain because not all investors are qualified institutional buyers.

309 For example, § 402(b)(8) of the Uniform Securities Act of 1956 defines the relevant exemption as "any offeror sale to a bank, savings institution, trust company, insurance company, investment company as defined inthe Investment Company Act of 1940, pension or profit-sharing trust, or other financial institution orinstitutional buyer, or to a broker-dealer, whether the purchaser is acting for itself or in some fiduciarycapacity" (emphasis added). Similarly, § 202(13) of the Uniform Securities Act of 2002 provides anexemption for "a sale or offer to sell to: (A) an institutional investor; (B) a federal covered investmentadvisor; or (C) any other person exempted by rule adopted or order issued under this [Act]."

310 California (C AL. CODE REGS. tit. 10, § 260.105.13.1 (2011)); Florida ( FLA. STAT. ANN. § 517.061(7));Louisiana (LA. REV. STAT. ANN. § 51:709(4)); Maryland ( MD. CODE REGS. 02.02.04, § Rule.04); ( MASS.CODE REGS. tit. 950, § 14.401 (2011)); Michigan ( MICH. COMP. LAWS § 451.2102a); New Jersey ( NEWJERSEY STAT. ANN. § 49:3-49 (West); New York ( N.Y. GEN. BUS. LAW § 359-e(a)); Ohio ( OHIO ADMIN. CODE§ 1301:6-3-02(D) (2003)); Texas ( 7 TEX. ADMIN. CODE § 109.4); Wisconsin ( WIS. STAT. § 551.102); BlueSky L. Rep. (CCH) ¶¶9,136 & 9695L (Arizona); 15,520 (Delaware); 16,758 (District of Columbia); 21,644(Idaho); 24,675 (Indiana); 27,579 (Kentucky); 35,587 (Missouri); 36,517 (Montana); 39,623 (NewHampshire); 44,527 (North Dakota); 47,667, 47,668 (Oregon); 49,602 (Puerto Rico); 50,505 (RhodeIsland); 57,468 (Utah); 58,414 (Vermont); 61,810U (Washington); 63,641 (West Virginia); and 66,464(Wyoming).

311 Occasionally, underwriters request that counsel prepare a "blue sky" survey describing the criteria for thestate-law exceptions, so as to provide specific guidance to sales personnel. However, this practice, whichwas standard in public offerings prior to the enactment of the NSMIA, is virtually unheard of in privateplacements today, at least where they are conducted under Rule 144A or otherwise limited to QIBs.

312 California, Louisiana and Vermont exempt from their registration requirements offers and sales made incompliance with Rule 144A as in effect from time to time. See supra Note 310.


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313 This could also include Rule 144A offerings by reporting issuers with nonreporting guarantors.314 It remains to be seen whether any of those states would pursue an enforcement action in such a case.

Practitioners may ask the SEC to use its authority under § 18 of the Securities Act to preempt "blue sky"laws for all offers and sales made pursuant to Rule 144A, which would align them with the existingpreemption for all offers and sales made pursuant to Rule 506, but this request has been made before, andthe SEC has yet to address it.


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U.S. Regulation of the International Securities and Derivatives Markets, §7.10, APPLICATION OF…

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7.10, APPLICATION OF REGULATION M TO PRIVATE PLACEMENTS



Regulation M under the Exchange Act [315] governs the market activities of issuers, selling securityholders,underwriters and other participants in securities offerings, and certain of their affiliates. [316] Regulation Mconsists of six rules, including a definitional rule (Rule 100). Rules 101 and 102 regulate bids for and purchasesof securities in "distribution" in the United States (and certain related securities) by participants in the distributionand certain of their affiliates. Rule 101 regulates bids and purchases by underwriters, prospective underwritersand other distribution participants, and affiliates of such persons that fall within the definition of "affiliatedpurchaser." Rule 102 regulates bids and purchases by issuers, selling securityholders and their affiliatedpurchasers. Rule 103 governs passive market making by Nasdaq market-makers participating in a distribution.Rule 104 regulates stabilization to facilitate an offering. Rule 104 also adds disclosure and reportingrequirements regarding certain post-distribution activities, including purchases to cover syndicate short positionsand the imposition of "penalty bids." Finally, Rule 105 restricts short selling in connection with a registeredoffering.

The determination whether an offering constitutes a distribution in the United States for purposes of RegulationM is based on the "magnitude of the offering" and the "presence of special selling efforts and selling methods."[317]

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Offerings subject to Rule 101 include private offerings where the indicia of a distribution are present.

Regulation M, however, by its terms has only limited application to transactions under Rule 144A. In particular,Rule 101 and 102 contain exemptions for distributions of Rule 144A-eligible securities of any issuer, U.S. or non-U.S., if such securities are sold in the United States only to QIBs or persons reasonably believed to be QIBs intransactions exempt from registration under § 4(a)(2), Rule 144A or Regulation D under the Securities Act. [318]

The exemption also applies if the distribution includes certain persons in the United States not deemed to be"U.S. persons" for the purposes of Regulation s under the Securities Act. [319] Rule 104, which governs stabilizingtransactions, contains comparable exemptions. [320] The exemptions would not, however, be available for adistribution of securities that are not Rule 144A-eligible, for example because of the fungibility or informationdelivery requirement of the Rule, [321] or that are not sold only to QIBs, for example because sales were alsomade to institutional accredited investors. [322]

Footnotes

315 SEC Release No. 34-38067 (Dec. 20, 1996) (the "Regulation M Release").316 For a discussion of Regulation M in the context of global offerings and enforcement, see §§ 3.02[8][a] and

11.05[3][c], respectively.317 Rule 100 of Regulation M under the Exchange Act.318 Rules 101(b)(10)(i) and 102(b)(7)(i) of Regulation M under the Exchange Act. As a result of the mandate of

§ 201(a)(2) of the JOBS Act, the SEC amended the exemptions under Rules 101, 102 and 104 ofRegulation M to conform to the amendments to Rule 144A by eliminating references to "offered" and"offerees."


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319 Rules 101(b)(10)(ii) and 102(b)(7)(ii) of Regulation M under the Exchange Act.320 Rule 104(j)(2) of Regulation M under the Exchange Act. However, unlike the exemptions provided in Rules

101 and 102 for securities eligible for resale under Rule 144A, the exemption contained in Rule 104(j)(2) iscurrently limited to the subject security. The SEC has stated that, when Rule 104 was adopted, the scope ofthe private placement exemption under it was intended to be identical to that provided in Rules 101 and102. SEC Release No. 33-8511 (Dec. 9, 2004). Accordingly, the SEC proposed to extend the Rule 144A-eligible securities exemption in Rule 104 to reference securities (that is, any security into which a subjectsecurity may be converted, exchanged or exercised (whether immediately or not), or which, under theterms of the subject security, may in whole or significant part determine the value of the subject security).See SEC Release No. 33-8511 (Dec. 9, 2004). As a consequence of this extension, in the context of anoffering of Rule 144A-eligible convertible bonds, for example, Rule 104 would not apply to transactions inthe underlying equity securities. This proposal was never adopted. For a discussion of Rule 104 generally,see § 3.02[9][b].

321 See § 7.02[3][c] and [d].322 For a further discussion of Regulation M, see § 3.02[8][a].


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Documents

U.S. Regulation of the International Securities and ... · offerings. Securities purchased in U.S. private offerings are viewed as "restricted" under SEC rules and thus may not be